Mumbai: The International Finance Corp. (IFC), an investment arm of the World Bank, will continue to monitor commercial banks with the same tools that were in use before the crisis, but apply them more stringently.
Safe and sound: Higgins says IFC has started a bank recapitalization plan for equity support to some financial institutions in the global market. Abhijit Bhatlekar / Mint
In an interview, IFC’s principal banking specialist Michael Higgins, who was in Mumbai recently for a seminar on risk management, said the measures will be different for different countries and the required capital adequacy ratio (CAR) or capital as a percentage of a bank’s assets, a key measure to gauge a bank’s solvency, may go up in the future.
Incidentally, India is in the process of recapitalizing its public sector banks that account for about 70% of the banking industry. India has asked for about $3 billion (Rs15,480 crore) from the World Bank to raise CAR of state-owned banks.
Under the current norms, banks need to have 9% CAR, but the government wants each bank to have at least 12% CAR. Edited excerpts:
Why is the banking system in a mess?
I would attribute the origin of the crisis to two areas. One would be the institutional practices and the other external environment that exacerbated some of the practices undertaken by the banks.
The origin of the crisis probably can be traced back to 2003, when banks in America started to aggressively originate subprime mortgages. Then, as investment banks started to originate and market collateralized debt obligations, it gave rise to a situation where the soundness of various credits being securitized became more and more questionable.
Around this time, the shadow banking system started to emerge in terms of credit default swaps and derivatives and it became more and more difficult as some of these assets had to be marked to market (an accounting practice where investments are valued at the current market price rather than at its historic price). The commercial banks didn’t have full confidence in dealing with their counterparts.
Eventually what happened was that commercial banks became careful in advancing credits towards other banks and also to some of their customers. It’s from there that much of the current difficulties originated.
There was a low interest rate environment worldwide and this qualified many potential clients to come to financial institutions, either to access subprime mortgages or other mortgages, which inflated the asset values. This, in turn, gave lenders comfort that these first-time borrowers might actually be worthy borrowers.
The combination of these situations really, surely, created the knock-down effect.
Have we seen the worst of it?