Efforts to raise capital requirements on cross-border lending could backfire, reducing capital flows and increasing borrowing costs in emerging markets, bankers attending the annual meetings of the World Bank and International Monetary Fund warned Sunday.
At issue is a series of proposals by the Basel, Switzerland-based Committee on Banking Supervision, which has set global ground rules for bank capitalization since 1988. As part of a broad revision of existing practices, the committee has proposed that banks set aside capital against cross-border lending on the basis of sovereign risk assessments from credit rating agencies. (See related story on page 2.)
Although banks already use internal risk models to determine how much capital should be set aside on such lending, the proposals would give them far less flexibility, bankers said. At a session sponsored by the Institute of International Finance, Federal Reserve Bank of New York President William J. McDonough acknowledged bankers' concerns. But if lenders consider the proposed system inadequate, he challenged them to "come up with something better."
Mr. McDonough, who also heads the Basel Committee, urged bankers to submit formal comments on the June 3 proposal. The comment deadline is March 31.
Bankers were unusually outspoken on the committee's plans.
"We're going through a period of declining capital flows to emerging markets," said John H.R. Bond, group chairman of London-based HSBC Holdings PLC. "Actions which go against the grain could discourage further flows."
Emerging-market bankers also raised objections.
According to Roberto Setubal, president of Brazil's Banco Itau S.A., higher capital requirements on lending to Brazil would result in a 70 to 100 basis point increase in borrowing costs for Brazilian banks.
Mr. Setubal also pointed out that the Basel Committee proposals do not make allowances for how well a borrowing bank in an emerging-market country might be capitalized nor for the type of credit that is being extended. This could have a disastrous impact on short-term trade finance, which is the lifeblood of emerging markets and has been almost completely free of defaults, he said. Major credit rating agencies, he added, also still have only a limited presence in emerging markets, making it hard for them to gauge different degrees of risk.
"The proposals do not differentiate between different types of risk, and markets often have a very different perception of risk," Mr. Setubal said. "Don't add rules which lead to unnecessarily high costs of financial intermediation."
According to forecasts by the Institute of International Finance, which represents some 300 banks around the world, capital flows to emerging markets will hold steady at $136 billion this year, virtually the same amount as in 1998, and will rise only slightly to $155 billion next year. Most of the increase is expected to come from capital flows to Latin America, which are expected to grow roughly 42%, to $85 billion, next year.
However, overall capital flows are still well below the record $355 billion set in 1996 and $266 billion in 1997.
Banks have come under increasing pressure in the wake a global financial crisis in emerging markets that started in Thailand two years ago and then spread across the Far East, then to Russia and Brazil. Banks have been blamed for helping to provoke the crisis by funneling reckless lending into emerging markets, which prompted the International Monetary Fund and G-7 countries to propose controls on future global capital flows.
Federal Reserve Board Chairman Alan Greenspan said in a speech Monday that the crisis could have been mitigated if emerging-market borrowers had had the alternative of issuing securities.
"Improving deficiencies in domestic banking systems will help to limit the toll of the next financial disturbance on their real economies," Mr. Greenspan said. "But if, as I presume, diversity within the financial sector provides insurance against a financial problem turning into economywide distress, then steps to foster the development of capital markets in those economies should also have an especial urgency."
On Saturday, IMF First Deputy Managing Director Stanley Fischer warned that "shareholders of the IMF will not support large-scale financial packages in the future if there is not some sort of private-sector financial involvement."
Paul A. Volcker, former Federal Reserve Board chairman and currently chairman of the Group of 30 think tank, noted that opinion over the solution is becoming increasingly divided. "One view is that the crisis was painful but temporary and a catalyst for change," Mr. Volcker said. The other, he added, "is that global capitalism and finance is unsafe for small, open economies with different traditions."
However, Charles Dallara, the Institute's managing director, said continuing uncertainty about public policies and anxieties over forced solutions now being drafted by the monetary fund and G-7 countries are decreasing capital flows to emerging-market countries. He particularly attacked efforts to force private creditors into accepting revisions on loan and bond contracts for financially troubled countries.
