Banking on tougher rules to protect lenders

Banking on tougher rules to protect lenders

Actions by central banks such as the US Federal Reserve in areas such as interest rates tend to grab financial news headlines across the globe.

Yet, the recent steps they have taken to make banking safer hardly attract any attention at all.

This is ironic. A simple analysis of the causes of the stock market roller-coasters in the past five years would show that most of them were almost certainly triggered by some banking crisis brewing somewhere in the world.

The measures by bank regulators may sound technical and lack the populist appeal of moves such as a cap on bankers' bonuses or a tax on financial transactions. But the measures will have a fundamental impact on how banks work and will hopefully lessen the chance of them failing in the next major financial crisis.

Last week, the US Fed said that US banks would need to obey the new, tougher international Basel III standards, which require lenders to increase their capital to at least 7 per cent equity against their risk-weighted assets over a period of five years.

Put simply, this essentially means that for every $1 which a US bank lends out, it must be backed by seven cents of the lender's own money. That may not sound like much if the lender were to face a sudden cash crunch, but US banks were used to even lower capital requirements before the 2008 global financial crisis.

In contrast, Singapore lenders have had to put up with much tougher capital adequacy ratio arrangements.

OCBC Bank has a total capital adequacy ratio of 18.1 per cent, followed by United Overseas Bank with 18 per cent and DBS Group, whose capital adequacy ratio is 15.5 per cent.

The other big reform taking place is the drive to push derivatives being traded over the counter among banks to trading on exchanges and settling within clearing houses.

It addresses one of the biggest weaknesses exposed by the 2008 financial crisis - the over-the-counter trading of credit default swaps, which led to the near-collapse of US insurance giant AIG.

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