Basel-III: The norms are not suited for emerging world banking --Published in ET on24 SEP, 2012, 06.30AM IST,
There are fundamental differences between financial systems in advanced market economies (AMEs) and those in emerging market and developing economies (EMDEs). These differences, inter alia, explain why financial intermediation held up relatively well in these economies even as financial markets froze in AMEs during the recent global financial crisis.
The biggest difference is that AMEs have increasingly moved towards reliance on short-term money and capital markets for funding, and 'money created' against volatile financial assets and innovative products exchanged over the counter ('shadow banking'). EMDEs, however, continue to be dependent on more stable deposit-based funding. This difference is critical.
Financial systems in both EMDEs and AMEs become vulnerable during downturns in the business cycle on account of deterioration in asset quality. Ever since deposit insurance was put in place following the banking panic during the Great Depression, deposit-based banking is no longer susceptible to funding risks arising from financial panics and bank runs.
As long as their capital is calibrated to cover asset quality deterioration during business downturns, EMDE banks no longer face major funding risks other than a general decline in financial savings, as long as external currency-denominated deposits are kept within prudent limits through capital controls.
AMEs are, in addition, exposed to funding risks arising from financial panic characteristic of build up of leverage in capital markets. This vulnerability has increased following the repeal in 1999 of the Great Depression-era Glass-Steagall Act in the US that drew a firewall between deposit-based banks and those (investment banks) that rely on capital markets.
Basel-II banking capital norms were calibrated to cover risks arising out of traditional deposit-based banking. They were not designed to cover funding risks emanating from sharp maturity mismatches and attendant difficulties in rolling over credit on account of financial panic that can result in rapid deleveraging, credit freeze and a breakdown in financial intermediation.
Financial panic has in some way or the other always been preceded by a considerable rise in leverage. The primary drivers of leverage in AMEs and EMDEs are strikingly different. Increasing leverage in AMEs in the period leading up to the global financial crisis was an attempt to increase returns on capital in an environment of low returns.
High credit growth in EMDEs, like India, on the other hand, was primarily to finance high rates of growth and investment in the real economy. The returns on capital in EMDEs are now significantly higher, as a result of which global production has long been migrating to these countries.
There was, of course, also speculative investment in certain asset classes, but margins on such credit were incrementally raised in response to the rising pace of credit expansion through conservative macro prudential financial regulation. This is a defining characteristic of EMDEs like India, where regulators have not hesitated to spot and prick asset bubbles, rather than simply waiting to clean up after they burst.
Following the recent global financial crisis, a slew of financial regulatory reforms are being contemplated under the aegis of the G20, Financial Stability Board (FSB), the Basel Committee on Banking Supervision (BCBS) and other standards-setting agencies to protect the integrity of financial intermediation.
Are these headed in the right direction? EMDEs clearly need to increase financial savings to accelerate growth and development, notwithstanding the fact that in recent years, capital was flowing uphill from EMDEs to AMEs. This was arguably a temporary and unsustainable phenomenon that may be about to change as theglobal economy rebalances.
AMEs, on the other hand, need major regulatory changes that inoculate them more effectively against the risks their financial system face, and also roll back some of the more extreme forms of financialisation that exposes them to greater risk in the first place without commensurate impact on growth.
While financial regulatory reforms are expected to be implemented across all jurisdictions, the immediate impact of most would be felt acutely in the relatively lightly-regulated AMEs, rather than in the more tightly-regulated EMDEs. The impact of the new Basel-III banking capital adequacy norms, however, will be almost equal across both AMEs and EMDEs even though the nature of risks in their financial systems is quite different.
|Levelling bank playing field just got jostled|
|Daniel Indiviglio / Sep 20, 2012, 00:30 IST (Business Standard )|
The worldwide playing field for banks had been levelling but just got jostled. One of America’s top regulators said on Friday the Basel III accord should be scrapped. Thomas Hoenig, vice-chairman of the Federal Deposit Insurance Corp, urged adoption of a simpler, stricter leverage ratio. A year after Jamie Dimon called the new worldwide global capital standards anti-American, the latest sign of resistance will only stoke fears about the US commitment to new rules.
The former president of the Kansas City Federal Reserve Bank joined the anti-complexity bandwagon. Hoenig contends that the 1,000 pages of capital rules introduce even more unwanted complications into an already overcomplicated bank supervision regime. Just last month, Andy Haldane, from the Bank of England, argued much the same against the “Tower of Basel.”
Hoenig wants banks judged on a more straightforward ratio of tangible equity to tangible assets. That would get rid of imperfect risk ratings. In his somewhat radical and belated plan, however, Hoenig first would need retail banks to shed their investment banking arms. Even that wouldn’t necessarily make them safer, though. A leverage ratio also can be gamed. To maximise returns, lenders could still load up on high-yielding but risky assets.
The quest for simplicity is understandable. Hoenig, however, in his speech honed in on Basel without factoring in other initiatives like living wills and the Volcker Rule designed to protect the system. More likely, and concerning, is that US bank executives, regulators and policymakers will latch on to his broader conclusion: that if Basel III isn’t revisited, the United States should refuse to implement it.
The rest of the world has already been pretty worried about that scenario. After leading much of the charge on the Basel II accord, signed eight years ago, the United States was slow to embrace it. Most US officials have been making the right sounds about Basel III. Dimon and other bank bosses also aren’t likely to sign up quickly for Hoenig’s ratios either. Financial institutions and authorities globally needn’t fear the worst about regulatory arbitrage just yet, but they’re right to remain wary.