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Freeing up credit flow the major challenge

By Hong Liang (China Daily)
Updated: 2009-03-17 07:48

Since the outbreak of the financial crisis in 2008, a major challenge confronting monetary officials of many economies has been one of unblocking credit channels.

This is an issue that will certainly be the focus of attention when leaders of 20 nations meet in London next month to address the worsening financial problems dragging many major economies deeper and deeper into a recession. The crux of the issue lies in the vicious cycle of asset devaluation that is making it progressively difficult for banks to make fresh loans.

As asset values fall, banks are forced to keep on selling down their holdings and to curtail their lending to meet the international accepted capital adequacy ratio. The sell-down has the effect of further depressing asset values, requiring banks to dispose even more to maintain their ratios, resulting in a further tightening of credit.

To free the credit seizure under these circumstances, governments have little choice other than to pump copious amounts of fresh capital into the troubled banks so that they can slow down the disposal of assets and resume lending to their most credit worthy customers. Despite the billions of dollars that have already been injected into the banking systems in the United States, the UK and other European countries, there is no sign of a bottoming out of the global asset down spiral.

The financial crisis is far from over, and, on the eve of the second 20-nation conference, many economists are warning about the onset of a so-called "second wave" of a potentially more destructive magnitude than what the world has experienced so far.

As Hong Kong Monetary Authority boss, Joseph Yam, puts it: "The severity of the current downturn in the global economy may be at least partly attributable to the cyclical, and arguably pro-cyclical, nature of regulatory requirements such as capital adequacy, loan-loss provisioning and valuation, particularly when they interact with leverage."

A number of international standard-setting bodies are known to be studying ways to address the "pro-cyclical" effects of regulatory requirements. Financial officials around the world are, no doubt, keenly looking forward to their recommendations.

In some markets, like Hong Kong, where banks hold a much smaller portion of "toxic" assets in their investment portfolios, only minor adjustments in the supervisory attitude are seen to be sufficient to address the effect that the regulatory requirements may have on perpetuating an asset spiral that can intensify a credit squeeze.

At the advice of the Monetary Authority, banks in Hong Kong routinely keep a "cushion" capital ratio above the 8 percent level specified by law. In November 2008, shortly after the outbreak of the credit crisis in the United States, the Monetary Authority introduced a flexible scheme giving banks the option to reduce their capital adequacy "cushions" to meet loan demands without having to dispose of devaluated assets.

The "pro-cyclical" effects of other regulatory requirements for banks, principally loan loss provision and asset valuation, fall in the territory of international accounting standards, leaving little room for adjustment by bank regulators. However, the increased support for dynamic provisioning and the recognition of the shortcomings in the common practice of "fair valuation" are pointing the way to modifications that could bring greater stability to financial markets.

These are tough issues that need to be addressed on a global basis. We are holding high hopes for the London conference.

E-mail: jamesleung@chinadaily.com.cn

(China Daily 03/17/2009 page8)