Banks under Economic and Financial Stress:

Global Risk Scenarios:

The trends entailing the recent emerging markets outlook on the back-drop of an US economic slowdown could have substantial impact

on the growth sustenance of fast moving sectors like IT , Financial and banking in countries like China and India, as discussed in the recently concluded weforum in Davos, Switzerland. Many issues were discussed regarding economic growth, financial market turmoil, banking risks, climate change, exchange rate risk, International Trade, etc. The IMF in its recent speech has trimmed the world economic growth rate this year to less than 4 %( 3.9%), from a 4.5% forecast earlier.

Housing market slowdown in the US could trigger an widespread financial crisis if not well contained, a well-discussed topic in Davos, while the 'Team Bernanke' , and other Central Banks acting as a lender of last resort to prevent contagious defaults, has put on every effort to contain the crisis by following market trends and financial strains of the banking and financial sectors, did well to respond promptly by cutting Fed interest rates along with liquidity infusion subsequently to ease the credit market seizures. Several banks like Citi Bank, Merrill and other have seen erosion of their banking capitals due to disproportionate capital write-downs of more than $ 11 billion, related to their subprime ABS exposures. The figure on the top left shows the total asset backed securities outstanding for each category like credit cards, home equity etc., for the year 2006 and more to follow in 2007-08.

Banking risks, Capitalization and Inefficiency: Where they stand?

Regulators have recently taken up the initiative to scrutinize and scan the banking operations and the rating agencies that grade credit-enhanced papers as tradable asset backed securities. Regulators may consider the compensation structures of banks that take too much risk in the market. Banking restructuring in the line of Three pillars of Basel II have also been revisited as banking risks on the event of a financial crisis are considered up as top priority. As one might ask, what are the risks that banks face in these scenarios?

Banking systems have different risk scenarios. For example, beside Systemic risks, they are prone to Economic risks like;

• Interest rate shocks
• Forex movements
• Loan loss (credit risks and credit obligations)
• Stock price movements
• Run-on-the bank due to contagious effect

Others risk factors like operational risks, information risk (proprietary info about financial engineering, confidential client data loss risk), default risk, inter-bank and market risks, Liquidity risks (Liability risks), idiosyncratic risks and risks stemming from financial linkages between banks. Banks may also be affected by business cycle shocks that may impact on a macroeconomic scale.

Need for Speedy Regulations:

Banking regulators and supervisors are placing more stress on market risk exposures on banks, since market leverage among investors plays an important role when things go the other way. Monitoring inter-bank liabilities within the whole banking system could be a better way to study rather than isolated cases of insolvency crisis. Regulators are wary about backing inter-bank credits with equity capitals, since loss in equity capitals could hamper banks loan repayment obligations. Moreover, effects of financial and economic shocks on the banking systems are looked upon since investment banks have a higher level of risky investment portfolio than other banks.

Image Source : The Bond Market Association