By Brai Odion-Esene
WASHINGTON (MNI) – Reducing government support for banks would
force them to be more disciplined in their actions and improve risk
management, making for a healthier banking sector, the Bank of
International Settlement argued in its annual report, released Sunday.
At a time when a number of countries, such as the United States,
have made explicit commitments to eliminate guarantees to bank
stakeholders, others with deteriorating finances — notably Spain — are
struggling to provide such guarantees.
“The perception that banks continue to receive substantial official
support persists,” the report noted.
It argued that reducing official sector support in the future
“would contribute to a healthier banking sector by ensuring that banks
factor their inherent financial strength into business decisions.”
The report said the withdrawal of government guarantees would lead
to stricter market discipline and give banks an incentive to behave more
prudently.
More generally, the BIS said lower government support would make it
necessary for banks to improve their inherent risk profile in order to
conduct traditional activities.
“For instance, banks are viable financial intermediaries only if
they secure lower funding costs than their borrowers, which would
otherwise tap markets directly,” the report said. “As funding costs
track credit ratings closely, a hypothetical withdrawal of official
support from European and U.S. banks at end-2011 would have made it
difficult for them to obtain funding more cheaply than potential
borrowers rated A- or above.”
“Likewise, lower ratings would have made it impossible for some
banks to act as counterparties in repo and derivatives transactions and
engage in market-making activities,” it added.
Casting an eye on the global banking system more broadly, the BIS
said the sector faces both short-term and long-term challenges.
The primary short-term challenge is that banks need to repair their
balance sheets, which will entail writedowns of bad assets — imposing
losses on banks’ stakeholders — and recapitalization, which public
funds could facilitate.
“With their balance sheets repaired, banks will be in a better
position to regain markets’ confidence and strengthen their liquidity
positions, both domestically and internationally, by drawing on
traditional funding sources,” the report said.
In the long term, the BIS said banks should have “sufficient
inherent financial strength” to perform key intermediation functions
without resorting to official support.
And with the expectation that the new regulatory environment will
exert pressure on their profitability, the BIS said banks will need to
adopt more aggressive cost management strategies than in the past.
The report counseled that to enjoy long-term success, banks will
need to adapt to a new financial environment, shaped by the lessons of
the recent crisis.
A key challenge will stem from permanently higher demand for assets
that can be pledged as collateral.
“As the role of central counterparties increases, for instance, the
collateral they demand for financial transactions is likely to encumber
a growing share of banks’ assets, even after the current crisis of
confidence has ended,” it said.
“High asset encumbrance, together with new resolution frameworks
that will impose greater losses on bondholders in the event of a bank’s
failure, will permanently raise banks’ funding costs, all else being
equal,” the report said.
The BIS said in order to restore confidence in the banking sector,
it is also critical that policymakers put pressure on institutions to
speed up the repair of their balance sheets.
And, despite calling for a decrease in official support going
forward, the report said public authorities could use fiscal space,
where available, to alleviate the strain on banks.
Bank balance sheets that become stronger and more transparent will
help to reopen their access to private sources of unsecured funding,
“thus reducing asset encumbrance,” the BIS said.
** MNI Washington Bureau: 202-371-2121 **
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