Academic journal article ABA Banking Journal

How Safe Is Your Bank?

Academic journal article ABA Banking Journal

How Safe Is Your Bank?

Article excerpt

Worldwide project team works for better answers

How safe is your bank? Safer than its largest competitor? Are affiliates in your holding company safer than their peers? Are your correspondents safer than their peers?

What if your biggest customer asked these questions? Or a major shareholder?

Could your answer rely on rating agencies' grades? Why should I accept bank ratings, your customer might ask, if banks won't accept customer ratings? According to news reports, banks are opposing regulators' proposals to use external credit ratings of customers in figuring their asset risks. Are banks any easier for rating agencies to analyze?

More questions could follow, just as crucial. Think back to the Asian currency crisis; the Russian default; the LTCM debacle. The biggest risks weren't even being identified or measured, much less controlled.

Could you compare these banks' relative safety, perhaps by using their published financial reports?

Not necessarily, according to the Federal Reserve Board.

Over two years ago, Fed Chairman Alan Greenspan warned that the complex activities of some large banks "may cause capital ratios as calculated under the existing rules to become increasingly misleading." That's one reason why the bank regulators are now calling for changes in those rules.

The banking industry is strong, you could say. During the summer, Greenspan said that banks were in good shape for an economic downturn. But he also warned that the next financial crisis is as certain as our inability to anticipate it--which he found "disturbing." And with increasing frequency, Fed governors have been making it clear that uninsured stakeholders should not look for a federal safety net beneath failing banks. The Fed has signaled that it plans to show the market, at some point, that no American bank is "too big to fail," thus sharpening investors' incentives to raise the cost of funding for the weaker links. It's an issue of even greater importance with the passage of financial modernization legislation.

The capital genome

The need to answer accurately these questions of bank safety is driving one of the most intensive, well-coordinated efforts in banking history. Teams of bank supervisors, practitioners, and academics from every major nation are cooperating to solve the banking industry's version of the Human Genome Project.

Bank supervisors, much like their medical counterparts, are attempting to sequence the elements that control the health and safety of the financial system. In task forces and committee rooms, bank researchers are trying to build a map of the most crucial elements in those chains of rights and liabilities, all of which make up the financial assets binding every bank to every market, large and small, local and remote.

The project's strategic goal, set out by G-7 finance ministers and central bankers in a 1999 report, is for "improving arrangements for the surveillance of global vulnerabilities, including the pooling of information ..., the development and assessment of macro-early-warning indicators, and the creation of procedures to ensure that information reaches the relevant parties." Shortly after publication of the G-7 report, the Basle Committee on Banking Supervision released its recommendations for changes to the 1988 Capital Accord.

Amid changes to the capital standards, the Basle reforms also added two new components to the accord: supervisory review and market discipline. The concept was almost philosophical. In May, 1999, lust before the issuance of the consultative paper, Claus Norgren, head of Sweden's Financial Services Authority, told a group of British bankers that "Capital adequacy is not just about fulfilling a numeric requirement for minimum capital. It is concerned also with an ability [to control risk] and an institutional mind-set."

Four U.S. bank supervisory agencies, moving swiftly to embrace the reforms, issued a set of joint policy proposals in March, 2000. …

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