Sunday, May 30, 2010

Bankers’ ‘doomsday scenarios’ under fire

The FT reports that "banks are exaggerating the economic effects of the regulations they are likely to face in the coming years" according to Stephen Cecchetti, chief economic adviser to the Bank for International Settlements:

Banks’ “doomsday scenarios” were based on their assuming “the maximum impact of the maximum change with the minimum behavioural change”.

“They are assuming they’re not adjusting their business at all to the regulatory reforms and that the result for the economy will be the worst possible,” said Mr Cecchetti.

Instead, Mr Cecchetti, who has been given a mandate to assess the economic effects of the “Basel III” reforms by the Basel Committee on Banking Reform and the Financial Stability Board, is adamant the transitional costs of requiring banks to hold more capital and be more robust to sudden demands for funds “aren’t huge”.

In the longer term, Mr Cecchetti said the result of a safer banking system would provide economic benefits not costs. “Our preliminary assessment is that improvements to the resilience of the financial system will not permanently affect growth – except for possibly making it higher.”

He gave three examples of banks over-estimating the likely effects of the new regulations, which are due to be agreed by the end of the year, with gradual implementation expected to start in 2012.

First, he said banks are claiming that new liquidity rules would force them to swap large quantities of high-yielding loans for low-yielding government bonds, which would have an impact on their profitability and lending. Instead, he said they could comply with the rules by lengthening the maturity of their liabilities so they better match those of their assets at much lower cost.

Second, he said they assumed investors would demand the same returns on new tranches of equity capital when this equity would make banks more resilient, lowering risk to equity holders and the cost to banks.

And third, he said the warnings of high costs relied on banks’ estimates that the new rules would reduce credit growth and economic growth severely. “We must always keep in mind that one of the causes of the crisis was that credit growth was too fast.”

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