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?
I would like to think that we have probably experienced some of the worst aspects of the financial crisis. However, because it’s a global phenomenon and incredibly complicated it would be premature to make a judgement one way or the other on whether we have seen the worst or when the end will come.
But even if the end comes in sight, we don’t know whether the rebound would be vigorous or whether it will be very anaemic. And, therefore, touching the bottom and growing thereafter may really mean new equilibrium as opposed to a bungee-jump return to prosperity.
The global meltdown has affected the emerging markets economies. When the recovery happens, who do you think will be the first to bounce back?
I think it’s difficult to differentiate between emerging economies. Some of the economies in some part of the world will be more affected than others. And some of them that have been less affected by the financial crisis may not see change at all because they are simply weathering the current situation.
Others, for example China, which depends on exporting prowess to fuel its growth, may be able to turn to its robust internal marketplace to replace that demand (export).
I think it’s important in this situation to see each emerging economy separately and not categorize them as having the same kind of character.
How do you assess struggling big banks? Do they have the capacity to pull through the bad times and become behemoths again?
We would still use the same tools to measure them. In terms of looking at theasset quality, liquidity, the soundness of managements, earnings, capital levels, etc. But some of the norms that we may apply may be more demanding than what we had in the past.
So, the levels (of equity relative to assets) that were considered sound in the past when we had periods of strong growth, may not be applicable now.
Can you tell us what should be the ideal level?
Under Basel I (an international norm for banks’ capital adequacy) the minimum CAR was 8%. Under Basel II, it has increased and different countries can modify levels. But in a recent study, Alan Greenspan (former US Federal Reserve chief) has predicted that by the year 2014, the market may demand capital levels quite a bit higher—may be an equity to asset level of about 14%.
At the end of the day, the adequacy of capital depends on whatever the market feels appropriate. And that would probably depend on the asset quality of the institution.
So, my view is that the tools that we use to analyse the banks remain same, but we will calibrate them more stringently in the future to determine the soundness and safety of the institutions.
Will that differ from bank to bank?
Banks in different markets may be viewed differently. Let’s say you have a market where there is a very high loan to deposit ratio, and there’s much more wholesale funding taking place. That adds risk to these banks and, therefore, the level of capital that we may feel necessary or prudent for a bank to maintain will be higher.
There have been big-ticket bailout packages planned by different countries. What’s IFC’s stance on that?
I think we are in favour of whatever measures regulators are taking for the safety and soundness of the institutions of different countries. If IFC can help them in anyway, we would be delighted to (do so).
We have put in place a bank recapitalization plan, which we hope would be utilized for important equity support to selected financial institutions in different markets globally.
We also have tripled our support for trade, which will help maintain the flow of trades by working with banking partners throughout the world.
Do you think these efforts are sufficient to protect banks?
We are taking these measures in conjunction with whatever efforts have been made by different banking systems to support banks.
As a fallout of these stimulus packages, fiscal deficits have been growing tremendously. Do you see any impact on the banking system?
The bailout approaches taken by different countries are falling into several different formats. One may be to guarantee assets, another to purchase troubled assets and yet another to inject capital in the banking system.
All these approaches have their pluses and minuses and only time will tell to what extent things will get affected.
The developed countries are heading towards a zero interest rate scenario. How long will this continue?
I don’t have an answer.
The setting of interest rates is one monetary tool that is used in different countries. There are also other tools that they can use. I am sure that once the rates go to zero or close to it, they will examine carefully what are the other options.