Friday, November 21, 2008

Basel Committee Strategy to Combat Financial Crisis.

Yesterday, the Basel Committee announced a "comprehensive strategy" to combat the banking crisis. Chief among the recommendations were:

  • Ensuring the risk capture process under the Basel II framework included both book and off-balance sheet exposures.
  • Increasing capital buffers that will aid in times of stress.
  • Increasing vigilance over liquidity levels at cross border banks through stronger supervisory frameworks.
  • Using Basel II to build up governance practices at banks.
For a full report click here.

While on the subject of Basel and its supervising body, Bank For International Settlements (BIS), back in September, Már Gudmundsson, the Deputy Head of the Monetary and Economic Department of the BIS, addressed the Financial Technology Congress at Boston.

A few of his observations presented at this forum on the current financial crisis:

-Financial institutions are in the process of reducing their leverage and size, by both selling assets and reducing staff. The result will be a smaller financial sector, at least for a while.
-The banking system will probably have to operate with higher capital buffers than prior to the crisis.
-There might be additional capital charges under Pillar 2 (supervisory review process). In addition, there is an active discussion taking place on the merits of introducing a limit on the leverage ratio of financial institutions, which, depending on where it is set, might call for more capital than otherwise at the peak of the next boom.
-Banking supervisors will demand high quality data and analysis.

During his speech, he painted a picture of the future of the financial sector in the years to come. Here are a few of his predictions:

"1. Higher capital and liquidity buffers and higher risk premia will entail a higher cost of capital and credit than before the crisis. That is not necessarily bad, as risk was underpriced.

2. Financial firms basing their business models on cheap access to funding in wholesale markets will either have to adapt or disappear. In the United States, the trend is currently towards universal banking. Competition for deposit financing will also be intense for a while.

3. On the product side, a premium will be put on simpler products because regulators and investors will remain sceptical of complex structured products and because management of financial firms will insist on understanding the products they offer, at least for a while!

4. The originate-to-distribute model remains to be fixed, and the interests of all the various players in the securitisation chain have to be better aligned. However, that does not mean that the model will disappear. At the fundamental level, the idea of distributing risk away from the institutions at the core of the financial system to investors that are willing and able to share in the risks is basically sound.

5. Finally, the financial sector will become smaller and less leveraged. That is the only way the sector can be returned to soundness and profitability in the environment that is likely to prevail in the post-crisis period. However, such retrenchment has to be seen against the earlier growth of the sector"
For a full report on his speech refer here.

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