Time has changed. Dramatic banking crises, in developed and emerging markets alike, have drawn attention to the costs and dislocations associated with weak or malfunctioning banking systems.
This was stated by JP Morgan Chase International President Andrew Crockett here on Friday.
He was delivering a lecture on "Recent international trends in banking supervision and regulations". It was the annual series of lecture organised by the State Bank of Pakistan (SBP) to name the series after its first governor Zahid Hussain.
National authorities and international community have recognised the importance of strong financial systems in the preservation of overall economic stability, he said.
Andrew said, "Bank regulations have risen to the top of the national and international policy agenda. So I make no apology for devoting my lecture to the recent and prospective trends in banking supervision.
He said 2004 would be a critical year in the development of a new global framework for the bank regulations.
The Basel Committee has undertaken the task to reach an agreement on a new capital adequacy framework (the so-called Basel II) by mid-year. This will be the most comprehensive overhaul of international capital adequacy standards since the first Basel accord was promulgated in 1988.
"In my view, it is a critically important step in modernising the framework for bank regulations. A setback to this process would have serious consequences," he said.
Luckily, the Basel Committee is near agreement on most of the outstanding issues. But there is still a risk that last minute objections will delay or even derail the process. This would be extremely unfortunate. Although there are concerns about specific aspects of the new accord, there can be little doubt that it is a major advance over what we have achieved now, he said.
But an even more important reason for regulations lies in the externalities associated with the activity of financial intermediation. To a far greater extent than in other industries, bank failures impose costs that go beyond the shareholders and management of the institution concerned. If a banking system is underdeveloped, then economic progress is severely handicapped. If it is not prudently managed, then the economy may be subject to periodic disruptive crises, he said.
Andrew said that one could think of the justifications for regulations and supervision as falling into four categories: enhancing efficiency, avoiding financial crises, protecting taxpayer funds, and preserving competitive equity.
Bank supervision has also become more comprehensive over time.
Initially, the supervisors were primarily concerned with monitoring credit risk, reflecting banks' historical role as mobilising funds, extending credit, and holding resulting exposures on their books until maturity. But the banks have significantly increased their trading activity. They are exposed to a variety of market risks.
They also face funding and liquidity risks, as well as operational risks. The supervisors have become increasingly aware of the need to track these risks, and to require the banks they supervise to hold adequate capital against them.
By the late 1990s, these shortcomings in capital regulations had been widely recognised to make a revision of the Basel accord necessary. The preparation of Basel II began in 1998. Now, six years and three consultative documents later, it appears as though Basel II will be agreed upon by the middle of this year.
Basel II attempts to deal with some of the criticism of the original accord through a three pillar approach. Pillar 1 is minimum capital ratios, but with expanded and more sophisticated set of risk weights. Pillar 2 is supervisory oversight and Pillar 3 is market discipline.
"To sum up, banking supervision has travelled a long journey over the last quarter century. This evolution has given us more robust but risk sensitive banking system. But it is a journey that can never be considered over," the JP Morgan president said.
Later, Justice Nasir Aslam Zahid thanked State Bank Governor Dr Ishrat Husain who took the initiative to start the series of lectures. He gave some observations on human rights in Pakistan and expressed deep concerns over the condition of women, especially those who are in jail for years and their cases not finding place in the courts.
Earlier, Dr Ishrat Husain introduced the chief guest to the audience and praised his contribution for the development in the banking system.
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