Anyone observing the current market volatility influenced by some troubled emerging markets should be concerned about whether global systemically important banks can withstand potentially prolonged turmoil. When I first heard the phrase "emerging markets and developed ones were decoupled" back in 2008, I argued that they might be like an old married couple: though they may not sit so close together anymore, they are, indeed, married.
Significant events emanating in developed markets affect emerging ones. The inverse is also true, especially now that for the first time in history, emerging markets represent 50% of global GDP in purchasing power. Also, some of the banks in emerging markets are much larger than they were in the early 2000s. In fact, a number of Chinese banks are now considered GSIBs, and they are more interconnected with banks in developed markets than ever before.
Often, when the media and analysts talk about bank exposure to emerging markets, they only refer to loans to counterparties in emerging markets or investments in sovereign or corporate bonds of those markets. Yet, GSIBs have other types of significant primary and secondary exposures to emerging markets that, due to banks' lack of transparency, are more difficult to identify.
Primary exposure to emerging markets also comes in the form of: trade finance, lines of credit, investments in foreign exchange portfolios or emerging market securitizations, minority or majority interests in companies located in emerging markets, and having derivatives counterparties with emerging market financial institutions. While some of these exposures may seem small, the composite could be large enough to merit concern.
Secondary exposure is in the form of loans or any capital market activities with asset managers exposed to emerging markets. Additionally, an important and difficult to detect secondary exposure comes from corporations from developed markets, which have subsidiaries in or transact with emerging markets. Particularly due to the effect of the global financial crisis, many companies including most commodity companies and some household names like Procter & Gamble, Colgate-Palmolive, Walmart, Coca-Cola and Pepsi have increased their presence in emerging markets substantially. Good luck in trying to see global banks' exact, direct exposure to any of these companies, since bank regulations, most unfortunately, do not require that level of public counterparty exposure.
In an interesting article, journalist Matt Egan questioned whether large banks can cope with the current emerging markets turmoil. The very fact that a journalist not normally dedicated to covering financial regulatory capital made capital a cornerstone of his article tells me that the market is not sufficiently confident about banks' capital health. A number of his sources mentioned that U.S. banks were better capitalized than they were before the crisis. Not only is this of very little comfort to me, it should not be to anyone else exposed to U.S. banks. This includes investors and taxpayers. Bank analysts, and even Fitch Ratings in a recent report, have published ratios that banks are adequately capitalized according to Basel III standards.
Firstly, the majority of the Basel framework is still based on banks using risk-weighted assets. Not only have I seen time and time again the level of flexibility that banks have in calculating their risk drivers that go into the Basel formulae, the Basel Committee's own studies have proven the need to have uniformity in RWA calculation. According to the committee's recently released agenda, this serious problem is unlikely to be resolved until 2015, if then. Even the leverage ratio which is supposed to serve as a backstop to the RWA framework, has ended up being watered down in its recent finalized version.
Secondly, it is important to remember that some of the Basel rules have only been finalized in Europe and the U.S. last year. Incremental implementation only began this year. It will be some time before bank regulators on either side of the pond feel sufficiently confident in banks' calculations for them to exit parallel runs, that is, reporting to regulators both under Basel II and III.
Thirdly, recent important documents released by the Basel Committee and the Senior Supervisors Group, prove what I have seen with global bank clients repeatedly: their data collection, aggregation and validation, along with counterparty monitoring ability, have serious shortcomings. It would be unwise to believe banks' capital ratios. Garbage in; garbage out. Until banks fix all their problems with data, and finally abide by Basel's Pillar III disclosure requirements, I hope that other journalists join Matt Egan in asking if banks can withstand the current emerging markets turmoil or tumult caused by anything else.
Mayra Rodríguez Valladares is managing principal at MRV Associates, a New York-based capital markets and financial regulatory consulting and training firm. She is also a faculty member at Financial Markets World.