Thursday, March 20, 2003
The financial sector’s role, the reason why it is granted a license to operate, is to assist society in promoting economic growth by stimulating savings, efficiently allocating financial resources satisfying credit needs and creating opportunities for wealth distribution. Similarly, the role of the assessor –in this case, the Bank– is to fight poverty, and development is a task where risks need to be taken.
From this perspective we have the impression that the Financial Assessment Program Report might revolve too much around issues such as risk avoidance, vulnerabilities, stress tests and compliance with international regulations, without referring sufficiently to how the sector is performing its social commitments.
As an example, only in Supplement 3, Development Issues in the FSAP, does the Bank acknowledge that; “for lower income countries with less-developed financial system, in order to be relevant to country authorities, the emphasis in the FASP must change… how residents can get a better access to a wider range of financial services”, having to confess, in the very same page, that “no formal methodologies exist for how to address development issues in the FSAP”.
Another example is present in the survey of countries’ experiences (Supplement 2), when in the case of Armenia, page 6, in response to the problems of “(i) weak credit culture with the prevalence of non-payments mechanism that undermine the development of the formal financial sector; (ii) limited access to formal, affordable financing by small and medium enterprises, a typical development trap in transition economies; and (iii) the slow pace of banking sector consolidation”, the only exemplified recommendations are; “(i) enhancement of the central bank’s ability to deal with insolvent banks, (ii) strengthening of penalty provisions and (iii) increase in minimum capital requirements”,
On a separate issue, the document Global Development Finance 2003 discussed last week and in relation to the minimum capital requirements of the Basel II proposals, states that they “include the likelihood of increased costs of capital to emerging market economies; and an “unleveling” of the playing fields for domestic banking in favor of international banks active in developing countries”. We believe that this issue, and similar ones, should be addressed in many FSAPs, specially as the Bank could perhaps act as an honest broker in such matters.
Dear staff, management and colleagues, it is an appropriate time to remember Roosevelt when he said that “the only thing we have to fear is fear itself” and so, repeating what we have said in may other occasions, we have to find ways of helping the Knowledge Bank evolve into the Wisdom Bank or, more humbly, the Common Sense Bank.
Mr. Chairman, although we already made a written statement, there are some brief comments that I wish to make in order to better illustrate our concerns, so please bear with me.
In Supplement 2, the Survey of Country Experiences, I believe that it is quite illustrative, that in the very, very first example listed: “After identifying the following problems: weak credit culture with a prevalence of nonpayment mechanisms that undermine the development of the formal financial sector; limited access to formal, affordable finance by small and medium enterprises; and the slow pace of banking sector consolidation”, the only recommendation put forward to the country in that example are: “enhancement of central bank’s ability to deal with involvement bank; strengthening of penalty provisions; and increase in minimal capital requirements.”
I don’t think that those are just the answers that should come from a development institution. We all know that risk aversion comes at a cost - a cost that might be acceptable for developed and industrialized countries but that might be too high for poor and developing ones. In this respect the Bank has the responsibility of helping developing countries to strike the right balance between risks and growth possibilities.
In this respect let us not forget that the other side of the Basel [Committee’s regulatory] coin might be many, many developing opportunities in credit foregone.
Why do I make these comments with such candor? Because personally I have been learning for many years the consequences of a financial puritanism that seems to be invading the world and that does not get the real culprits, either. In the specific case of my country [Venezuela] the commercial banks credit portfolio fell in real terms from about $16bn in 1982 to only about $4bn in 1997.
In such a scenario, to hear about Basel [Committee] and its regulations reminds one of the make up of an already rigor-morted corpse, although we must admit that in the case of this particular corpse, we should know that even almost six feet under, it has been able anyhow to generate surprisingly large profits.
I am certain that funds invested in FSAPs are very well invested funds, as fully attests that all the countries in my constituency to have done it. Nonetheless, in the area of risk management of finance, it might be an appropriate time to remember Roosevelt and that the only thing we have to fear is fear itself.
And so, repeating what I have said on some other occasion in this particular respect, I believe that we truly have to find a way of helping the Knowledge Bank to try to evolve into something more of a Wisdom Bank, or, to put it more humbly, at least a “common sense Bank.
Lets start by making sure these Financial Sector Assessment Programs are true development tools. In this respect I would really like to make a brief reference to the issue of collaboration with the Fund. I think this is a particularly clear case that shows where the collaboration should perhaps not be that intense, because as a development unit, we have to look at the growth potential of the sector, the development side, and they probably have to look at the safety side. And it is between this type of balance and continuing balance that we can really assist.
Finally on a related issue, last week in a seminar on housing finance we heard that Basel is getting to be a big rulebook—this was said by the Bank. And, to tell you the truth, the sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world, is by having an entity like the World Bank stand up to them—instead of rather fatalistically accepting their dictates and duly harmonizing with the International Monetary Fund.
As an example the Bank has for some time unsuccessfully been trying to argue with the accounting boards that, following their current rulings is not the best way of reflecting the Banks’ own financial reality. Well if the Bank has difficulties, imagine the rest of the world.
Monday, March 10, 2003
Chapter 3. Coping with Weak Private Debt Flows.
Argentina’s External Debt furnace was stoked over a long period of time by high ratings issued by the credit rating agencies who, when they awoke surprised by the resulting mountains of debt, speedily reversed themselves 180 degrees, putting new pressure on interest rates and reinforcing the tragedy of a self-fulfilling prophecies.
Venezuela, even though during the last couple of years has had a very low public external debt, less than 30% of GDP, which it has been servicing, has in a continuum been brought down to a highly speculative CCC rating, and has probably no alternative except that of waiting for a de-rating, the day the credit agencies happen to discover that it no longer has any outstanding debt.
We make these somewhat exaggerated examples so as to remark the fact that, in this otherwise very complete Global Development Finance 2003, there is no mention about the issue of the growing role of the Independent Credit Rating Agencies, and the systemic risks that might so be induced, when they are called to intervene and direct more and more the world’s capital flows.
It is not a small issue. Today many insurance companies and pension funds are already limited by the credit ratings for their investments and, for banks, we are only told things will get worse.
For instance, Basel II, page 47, states “risk weights would be set for a bank’s exposure to sovereigns, corporations, and other banks based on ratings from major credit-rating agencies… the new methods of assessing the minimum-capital requirement is expected to have important implications for emerging-market economies, principally because capital charges for credit risks will be explicitly linked to indicators of credit quality… the regulatory capital requirements would be significantly higher in the case of non-investment grade emerging borrowers than under Basel I", plus finally “The current proposal places project loans in a higher risk category than corporate loans”.
The sole fact that emerging countries, when affected by lower credit ratings, face additional difficulties to access investors with availability of long term financing, forces them into more short term arrangements which, compounded by the much higher rates charged, almost guarantee a crisis, once the snowball starts rolling.
Chapter 3 dedicates six full pages to the interesting issue of the search for better crisis management, especially the problems surrounding sovereign debt restructuring. We commend this discussion as we agree with the statement that “Debt crisis have severe implications for the poor, who had no role in making decisions on borrowing” but, this only highlights the importance of carefully identifying, reviewing and correcting the factors that might lead to a crisis.
We would also like to make a comment with respect to “Bank retrenchment in context”, page 45. It is said that “The significant presence of BIS-area deposit taking institutions is one of the most important ways in which the poorest developing countries” and that their presence “should improve the efficiency of the local financial intermediation system” but then, on page 47, Basle II, we read that “If, as expected, most domestically owned banks in emerging market economies adopt the standardized approach to credit risk, they will be at a comparative disadvantage vis-à-vis cross border lending by international banks when attempting to lend to high quality domestic borrowers”. There is a clear conflict between those two statements inasmuch the “comparative disadvantage” might justly be interpreted only as a disadvantage unfairly decreed by Basle, something which relates poorly to improving the efficiency of the local market.
With respect to Basle, we would also like to point out that the document does not analyze at all a very fundamental risk for the whole issue of Development Finance, being it that the whole regulatory framework coming out of the BCBS might possibly put a lid on development finance, as a result of being more biased in favor of safety of deposits as compared to the need for growth. Even though, in theory, we could agree that there should be no conflict between safety and growth, in practice there might very well be, most specially when the approach taken is by substituting the market with a few fallible credit rating agencies.
We would also like to comment with respect to credit derivatives. This market for credit risk transfer, that between 1997 and 2002 has “expanded more than ten-fold… reaching $ 2 trillion in outstanding notional value, expected to increase to US$ 4.8 trillion by end of 2004” and “yet the use of credit derivatives to manage risk is still only about 2 percent of their use in managing interest rate and currency risk” carries its own very clear and present danger of blindfolding the market as to where the real risks are truly allocated. Recently, and in relation to the losses from energy trading and their related derivatives, there have been reports that markets are still unsure on where the losses are finally going to surface… and be paid for.
As the financial sector grows ever more sophisticated, making it less and less transparent and more difficult to understand for ordinary human beings, like EDs, it is of extreme importance that the World Bank remains prudently skeptical and vigilant, and not be carried away by the glamour of sophistication. In this particular sense, we truly believe that the World Bank has a role to play that is much more important than providing knowledge per-se and that is the role of looking on how to supply the wisdom-of-last-resort.