Banks Warn Higher Capital Requirements Could Hinder Emerging-Markets Lending

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Efforts to raise capital requirements on cross-border lending could backfire, reducing capital flows and increasing borrowing costs in emerging markets, bankers attending the annual meetings of the World Bank and International Monetary Fund warned Sunday.

At issue is a series of proposals by the Basel, Switzerland-based Committee on Banking Supervision, which has set global ground rules for bank capitalization since 1988. As part of a broad revision of existing practices, the committee has proposed that banks set aside capital against cross-border lending on the basis of sovereign risk assessments from credit rating agencies. (See related story on page 2.)

Although banks already use internal risk models to determine how much capital should be set aside on such lending, the proposals would give them far less flexibility, bankers said. At a session sponsored by the Institute of International Finance, Federal Reserve Bank of New York President William J. McDonough acknowledged bankers' concerns. But if lenders consider the proposed system inadequate, he challenged them to "come up with something better."

Mr. McDonough, who also heads the Basel Committee, urged bankers to submit formal comments on the June 3 proposal. The comment deadline is March 31.

Bankers were unusually outspoken on the committee's plans.

"We're going through a period of declining capital flows to emerging markets," said John H.R. Bond, group chairman of London-based HSBC Holdings PLC. "Actions which go against the grain could discourage further flows."

Emerging-market bankers also raised objections.

According to Roberto Setubal, president of Brazil's Banco Itau S.A., higher capital requirements on lending to Brazil would result in a 70 to 100 basis point increase in borrowing costs for Brazilian banks.

Mr. Setubal also pointed out that the Basel Committee proposals do not make allowances for how well a borrowing bank in an emerging-market country might be capitalized nor for the type of credit that is being extended. This could have a disastrous impact on short-term trade finance, which is the lifeblood of emerging markets and has been almost completely free of defaults, he said. Major credit rating agencies, he added, also still have only a limited presence in emerging markets, making it hard for them to gauge different degrees of risk.

"The proposals do not differentiate between different types of risk, and markets often have a very different perception of risk," Mr. Setubal said. "Don't add rules which lead to unnecessarily high costs of financial intermediation."

According to forecasts by the Institute of International Finance, which represents some 300 banks around the world, capital flows to emerging markets will hold steady at $136 billion this year, virtually the same amount as in 1998, and will rise only slightly to $155 billion next year. …