Global financial integration has augmented the exposure to macroeconomic and financial vulnerabilities. In this scenario, prudential financial regulation presents challenges to success. First, banking assets and liabilities are vulnerable to changes in macroeconomic conditions. Second, segmented supervisory authorities do not cope with the universal scope of banks. Third, new regulatory patterns are generally proposed after banking innovations. At last, the consolidation of larger banks, stimulated by financial liberalization, changes in financial savings, capital adequacy requirements and information technology, have favoured the action of central banks as agencies that arbitrate competitive struggles.
Looking back, in the late 1980s, there was a global concern around the development of a new regime of prudential banking regulation, founded on the ratio of capital to risk-adjusted assets. The first Basel Capital Accord introduced the 8 % capital requirement on the risk-weighted value of a bank’s assets, mainly credit-risk. As of 2004, a new Capital Accord, Basel II, was settled and underlined three pillars: a bank’s core capital requirement; supervision and market discipline. This Accord aimed to spread out mechanisms of protection in order to avoid financial systemic risk and to favour informational transparency (disclosure). Therefore, the institutional set up would enhance more efficient financial leverage systems and greater transparency to financial regulators and investors.
Throughout the implementation of Basel II, banks proved to enhance asset-liability management (ALM), or even, balance sheet management, to reduce legally capital requirements. At the operational level, ALM involves new management practices and techniques to manage risks that arise due to imbalances in assets and liabilities. For example, banks could manage the credit risk with further securitization transactions. ALM could also be used to analyse market risks related to trading in capital markets. Besides, low capital requirements were supported by off balance sheet assets since great volumes of their trading books were shifted into SIVs (structured investment vehicles). The 2008 global crisis showed that innovations, such as banks’ asset-liability management, have reinforced systemic risks.
In the aftermath of the crisis, global biggest banks increased write-downs on loans while credit losses put pressure on profitability. The reduction of leverage and new strategies related to the internal reassessment of risks (credit, currency, interest, liquidity) have been implemented to maintain existing capital levels. Besides, uncertainty about the future evolution of the global economy has reduced the bank’s interest in foreign markets, mainly in U.S. and Europe.
Supervisory authorities have searched for setting new rules that could make the financial system more resilient in response to the crisis,. Among other issues, i) banks will need to hold larger capital requirements against further potential losses, ii) financial products’ approval would involve extensive disclosure requirements and iii) banks would be induced to negotiate standardized products. As a result, capital market transactions and trading income would lose their importance in a context where regulators would demand that some credit risk would be retained on the banks’ books. Due to higher equity ratios, future banks’ profitability (returns on equity) would probably shrink.
In the attempt to face the regulators’ potential actions, global biggest banks have already been seeking for new strategies and practices. Nevertheless, lower risk-weighted assets and higher capital ratios represent a challenge for increasing assets and profitability. As a result, global biggest banks seem to shrink under pressure from regulators.
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