Where's Basel II? Cracks in the armour...
Where's Basel II? Cracks in the armour...
The Basel Accords I and II were put in place to set standards on global banks recognition of capital. Yet the Credit Crunch of Aug 2007 seems to have put these guidelines at risk. Is Basel II effective in todays global capital and banking environment. What's going wrong?
A recent article from Financial Times highlights the issue.
Banks & Balance sheets - FT article (quoting a Merrill report) says US commercial banks have seen $280B of new debt come back onto their balance sheets during the summer credit crisis. As banks have had to accommodate this influx of assets, they have less room to lend out into the economy. According to data from the Federal Reserve, large bank capital represented by net assets had declined by $40bn since the beginning of August. According to Merrill - "This has never happened before over such a short timeframe and this is rather serious because such a steep and sudden compression in large-bank capital has the potential to create a negative lending environment,". Recall this is one of the major risks to the outlook cited by D. Malpass - the strained balance sheets of many banks will hurt lending, which will in turn translate into weaker eco growth going forward. On Citi's call Monday, one of the disappointments was the fact its capital ratios had become so stretched as to limit balance sheet growth and stock buybacks.
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Basel regulators believe crisis far from over-source
The global credit crisis is far from over and may come in waves, a source close to the Basel Committee on Banking Supervision said on Friday.
Regulators from around the world will meet next week to discuss what the source described as the "hard-core liquidity crisis" which has forced central banks to inject billions of dollars in emergency liquidity into the banking system.
But the source, who declined to be named, said the Basel Committee was unlikely even to discuss suggestions that central banks should become market makers of last resort when liquidity dries up, saying such an idea is out of the question.
Stock markets have hit record highs in recent days due to optimism that the worst of the credit crisis may be over, while primary U.S. bond markets and some loan markets have revived following the Federal Reserve's interest rate cut on Sept. 18.
But regulators on the Basel Committee are less optimistic as they gather in the Swiss city. "In banking and in supervisory circles, this crisis is far from over," said the source. "This crisis may unfold itself in waves."
The Committee will put the liquidity crisis, in which banks have been largely unwilling to lend to each another, at the top of its agenda, the source said.
"Liquidity hasn't played a big role so far but now we can see that we have a hard-core liquidity crisis," said the source. "This is something that has very rarely happened before ... where banks don't trust each other."
Liquidity -- or lack of it -- is one of the top risks for banking institutions, but rulebooks such as the international Basel II accord which the Committee drew up have focused instead on capital requirements.
STRESS TEST
Committee deliberations are unlikely to result in proposals for a new liquidity risk charge -- which would force banks to set aside more emergency cash -- but rather in guidelines or "soft regulations" on how to cope with crises, the source said.
"The core of the issue is stress testing and contingency plans," the source said.
The source said Committee members were unlikely even to debate suggestions by some private-sector bankers that central banks become market makers of last resort for illiquid assets to keep the wheels of international finance turning.
"This is out of the question. This is something the market wants but at the current time there is no debate on this," the source said.
"If any central bank opened this possibility, they would be flooded, literally flooded, with hundreds of billions in asset backed commercial paper," the source said. "This would be a classical case of bailing out the speculators."
The global credit crisis that developed in August was triggered by defaults on U.S. mortgage debt that had been extensively repackaged and sold as asset backed securities to institutions, including hedge funds, around the world.
Regulators have been torn between ensuring that markets keep working by providing emergency liquidity, and the risk that this will simply inflate another market bubble following the equities boom of the late 1990s and the property boom of this decade.
They are also anxious to avoid "moral hazard" in which investors, shielded from risk by official bailouts, are encouraged to behave increasingly recklessly.
Basel watchdog eyes tighter rules after crisis
The world's top banking regulators are mulling new safety rules in the wake of financial turmoil that has triggered a "crisis of confidence" among banks and major disruption in the global financial system.
Regulators and central bankers concluded a two-day Basel Committee meeting in Basel on Tuesday by urging tighter supervision and better risk management and calling on banks to shed light on complex and hard-to-sell investments.
A source close to the committee, speaking under condition of anonymity, said the situation was "fragile" but not "precarious" and said the group was on alert for further jolts that could send shock waves through the financial system.
"Because the markets are still at a delicate stage, the impact could be a little larger than in normal market conditions -- that's why it's important for supervisors and central banks to continue to be vigilant and to closely monitor the situation," the source said.
"There is a crisis of confidence," the source said.
The Basel Committee includes the world's top banking supervisors and sets the global standards banks employ to shield themselves from bad loans or surprise shocks that could throw the international financial system into disarray.
Central banks and regulators have launched forensic efforts to understand why the credit crisis, first triggered by the default of U.S. sub-prime mortgage investments, had such violent knock-on effects for the global economy.
The committee is still reviewing lessons learned from the crisis -- which saw big, global banks cease to lend to one another overnight, putting a huge strain on the international financial system -- and may modify how banks make emergency preparations for stressed market conditions.
But it was still too early to draw conclusions that could lead to rules changes -- partly because the crisis has not played itself out fully, the source said.
"We're keeping the door open," he said.
SPOTLIGHT
The committee's conclusions are likely to get considerable attention ahead of the G7 meeting of finance ministers in Washington later this month where the crisis, and ways to mitigate it, will loom large.
Lessons are still piling up, such as from the run on British mortgage lender Northern Rock (NRK.L: Quote, Profile, Research) last month where the bank's lending business remained sound but its market access to funding dried up.
The ministers are expected to analyse the crisis and possibly review oversight procedures for non-bank financial heavyweights which can wreak havoc in the financial sector, as the U.S. sub-prime mortgage crisis has illustrated.
Those include hedge funds, sovereign wealth funds or non-bank actors such as U.S. mortgage companies which have largely escaped the level of regulatory scrutiny applied to internationally active, systemically critical banks.
A separate group of international enforcers, the Financial Stability Forum, is expected to provide an analysis to finance ministers over what went wrong.
At the close of the two-day meeting, the committee threw its support behind the latest rewrite of global banking rules, known as Basel II, which has taken fire from politicians and central bankers in recent weeks.
Basel II, which was published in 2004, represents the biggest change in risk management in a generation and is due to go live in Europe in 2008 and in the United States one year later.
The committee said the new accord would create more incentives for improved risk management, especially in the types of asset-backed investments that triggered liquidity problems among banks in the current crisis.
The committee said it would soon propose new charges for risks posed by complex and illiquid investments when those investments are held on banks' own accounts -- a phenomenon known as trading book risk.
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posted by Victor Lloyd Smith @ 11:16 AM
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