Tuesday, February 17, 2009

In Canada, G20 sees banking's future

By Eric Reguly (Globe & Mail):

Canada and Spain might be the future of banking. As banks everywhere implode, get nationalized or survive by shedding assets with alacrity, the Canadian and Spanish banks are, relatively speaking, soaring. Regulatory regimes that once seemed stifling now appear enlightened, and seem to have done the trick.

The Group of 20 nations has taken notice and are looking to the Canadians and the Spanish for inspiration. Designing regulatory and risk-management systems that could prevent another financial collapse is the goal.

Canada is especially prominent on the regulatory leadership file. Tiff Macklem, the associate deputy minister of finance, was recently named the co-chairman of the G20 group, known as Working Group One, that is charged with enhancing the regulation of financial services and improving transparency. The other co-chairman is Rakesh Mohan, deputy governor of the Reserve Bank of India. Their report will be submitted to the next G20 meeting of finance ministers and central bankers, on March 14 in London, and is likely to feature prominently at the full G20 meeting in the same city in early April. "We have a lot of credibility on this file," Mark Carney, Governor of the Bank of Canada, said after the G7 finance ministers' meeting in Rome on Saturday.

While the Canadian and Spanish regulatory systems were not officially named as models at the Rome G7 meeting, the calls for a co-ordinated regulatory overhaul are getting louder by the day. "There is a general consensus that, to overcome this crisis, we need a new rules-based strategy," said Giulio Tremonti, Italy's Minister of Finance and the Economy. Mario Draghi, the Bank of Italy Governor, called for banks to have more capital, more reserves, greater supervision and controls on executive compensation. Christine Lagarde, France's Finance Minister, has said tougher financial regulation should be the focus of April's G20 summit.

While the Canadian banks have lost considerable amounts of stock market value - Royal Bank is down 36 per cent in six months - their strength is remarkable by global standards.

In the last four months, the Big Five banks have collectively raised about $9-billion in common equity and preferred shares. Their dividends have remained intact and their capital ratios are still comfortably above the regulatory minimum. So far, taxpayer funds have not been used to bolster them, though banking legislation has been amended to allow Ottawa to do so, if necessary.

The Spanish banking industry, dominated by Santander and smaller rival BBVA, is also in good shape by global standards.

In 2008, Santander, the biggest bank in the euro zone (the 16 countries that share the common currency), reported a profit of €8.9-billion ($14.1-billion) excluding capital gains, a 9.4-per-cent increase over the previous year.

In spite of higher levels of non-performing loans and the collapsing Spanish real estate market, Santander said earlier this month that it expects steady profits and dividends in 2009. It is one of the few banks in the world to make acquisitions since the Lehman Brothers bankruptcy in September.

Canadian and Spanish banks are generally better capitalized than others.

Canadian banks have an asset-to-capital ratio, also known as the leverage ratio, of about 20-to-1. Some of the big American and European banks have ratios twice as high.

"We should bring other banks to Canadian levels," Mr. Carney said.

Raising capital in moribund financial markets, however, would be exceedingly difficult. The Bank of Canada has estimated American and European banks would need to raise $1.2-trillion (U.S.) to bring their leverage down to Canadian levels.

Spanish banks distinguish themselves by being forced by the regulators to save for rainy days. They were pushed into "dynamic provisioning," in which they had to make higher-than-usual provisions during good times to protect them in bad times.

This gave the banks a countercyclical buffer. During economic downturns, Spanish banks can draw down on the surplus reserves. This reduces their need to liquidate assets or cut back on lending during tough times.

Spanish banks were also prevented from loading up off-balance-sheet vehicles (also called special purpose entities) with huge dollops of credit assets.

Creating an international set of standards to protect the banks from themselves will be difficult. The Americans typically resist "regulatory overstep" as an intrusion on their sovereignty. Some countries are in favour of tighter restrictions on their banks' leverage ratios but don't want it universally applied.

The Swiss, for instance, are exempting domestic, but not foreign, lending from higher leverage standards because they don't want to choke off loans within the country.

No one is yet talking about a global regulator, which raises the question as to who would implement and monitor any new standards.

It appears that the Financial Stability Forum (FSF), a body of central bankers, finance ministers and regulators, would propose the new rules on global standards such as bank capital ratios, while the International Monetary Fund might ensure the standards are implemented within various countries.

"The FSF has the potential to become a more formal group," Mr. Carney said.

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