The Winds of Change: the Regulatory Backdrop

Presentation to the APEC Study Centre: Joint Regional Symposium

R. Sean CraigIMF Resident Representative in Hong Kong SAR

Asia and Pacific and Monetary and Capital Markets Departments

Manila, June 27th, 2011

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The presentation reflects the views of the author not the IMF

Disclaimer

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Impact of the global financial crisis on availability of credit

The crisis triggered wholesale banking system reforms

These reforms will influence the availability of credit ahead

What steps will help ensure that credit is available to support

economic recovery and growth?

Outline

Bank credit is recovering more slowly than markets but EMs do well

Portfolio Flows, Real Credit and Real Equity Prices

(z score)

-5

-4

-3

-2

-1

0

1

2

3

Mar

-06

Jul-

06

No

v-0

6

Mar

-07

Jul-

07

No

v-0

7

Mar

-08

Jul-

08

No

v-0

8

Mar

-09

Jul-

09

No

v-0

9

Mar

-10

Jul-

10

No

v-1

0

Mar

-11

Real credit growth

Real equity prices Portfolio flows

-20

-10

0

10

20

30

40

50

Brazil

China

India

Indonesia

Real Credit Growth in Selected EMs(year-over-year percent change)

2006 2007 2008 2009 2010

Lending conditions remain tight as crisis still weighs on US and European credit

-40

-20

0

20

40

60

80

100

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

UnitedKingdom

Japan

Euro area

United States

Bank Lending Conditions

(net percentage of domestic respondents tightening standards for loans)

-30

-10

10

30

50

70

Mar

-09

Sep

-09

Mar

-10

Sep

-10

Mar

-11

United States

Mar

-09

Sep

-09

Mar

-10

Sep

-10

Mar

-11

Euro area

SMEs

Tighter

Mar

-09

Sep

-09

Mar

-10

Sep

-10

Mar

-11

United Kingdom

All firms

Tighter

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The financial crisis highlighted three vulnerabilities now targeted by

regulatory reforms that will affect credit availability

The failure of capital to provide adequate protection against loss

Delayed recognition of credit impairment

Need for stronger liquidity

The BCBS initiated major reforms of banks’ capital and liquidity

rules to address the vulnerability know as Basel III

Regulatory reform and credit availability

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Bank capital ratios will rise substantially by 2019 with add-ons

SIFIs will have to hold capital beyond this of 1% to 2.5%.

Some countries implement BIII on an accelerated schedule

Strengthening capital regulation

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Impact quite significant for Core T1

Large for banks in Group 1 with bigger interbank/trading book

exposures. €557 bn for Group 1 banks to get to 7%

Impact of BIII on capital in QIS

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Asian EM banks have CAR well above the new minimum, but

rapid credit growth will push down CAR, requiring new capital

Impact of BIII varies across countries

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The quality of capital is improved to raise loss absorption with

more common equity and less hybrid capital

Risk weighting adjusted to better reflects credit risk

Supervision strengthened to ensure regulation implemented

Accounting reforms of IFRS to allow more forward looking

provisioning

Some impact of BIII on credit but BCBS QIS find it to be modest

Regulatory reforms affecting credit access

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The experience of crises show that there is no tradeoff between

strong regulation and credit availability over the long run

Rapid credit growth facilitated by lax regulation leads to financial

crisis and a large contraction of credit

Expanding access to credit over the long term involves

strengthening the credit culture

Misaligned incentives that lead to excessive credit growth need

to be addressed

Financial stability is needed to ensure credit

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Don’t water down BIII: banks may need to issue more equity to

ensure regulatory tightening doesn’t slow credit growth

Use full scope for countercyclical capital buffer to limit fall in

credit in downturn

Strengthened pricing of credit risk ensures sustainable credit

Use scope in revised accounting rules to provision up front –

despite P/L impact – not when risk materializes (in a crisis)

Coordination among supervisors to limit regulatory arbitrage

Regulation must internalize credit effect