... more South Korea"s central bank cut interest rates to a record low, a move seen as an attempt to stem the economic fall out from an outbreak of the Middle East Respiratory Syndrome (MERS).... more
APAC Financial Markets • #CentralBank, #InterestRates, #MERS, #MiddleEastRespiratorySyndrome, #SouthKorea #MarketNews
Banks are set to face tougher international rules on the capital they must have on hand to cope with a change in interest rates, amid regulators’ concerns that current standards may be too flimsy to fully capture the risks.
The Basel Committee on Banking Supervision, a group bringing together regulators such as the U.S. Federal Reserve and the European Central Bank, proposed overhauling its current rules for interest-rate risk, including possible binding standards on how banks should measure their resilience to shock rate changes, and on the capital they should have to cover potential losses.
The work “is particularly important in the light of the current exceptionally low interest-rate environment in many jurisdictions,” the Basel committee said June 8 in astatement on its website. The committee wants to ensure that “banks have appropriate capital to cover potential losses from exposures to changes in interest rates.”
Global central banks have pushed interest rates to historic lows in a bid to counter the worst financial crisis since the Great Depression. The ECB, as well as monetary policy chiefs in Denmark and Switzerland, are among those to have pushed some rates below zero in a bid to spur bank lending and stimulate economic growth.
U.S. Fed Chair Janet Yellen said last month that she expects to raise interest rates this year if the economy meets her forecasts, with a gradual pace of tightening to follow.
The Basel proposal concerns possible losses on assets that banks intend to hold to maturity, a part of their inventory known as the banking book.
International standards in this area are currently limited to a system whereby banks regularly report to their national supervisors on risk levels. These supervisors then take decisions on whether more capital, or a reduction in the size of the position, is needed.
The plans published for consultation by the committee today set out two options for strengthening this banking book regime. The regulator seeks views on the plans until Sept. 11.
The first would toughen the current supervisor-led approach, including by boosting the amount of information that banks have to disclose.
The second, more radical option would see this system replaced by minimum capital requirements set centrally by the Basel committee, which nations would be expected to make binding on their banks.
These requirements would include a methodology for “shock scenarios” against which banks should pit themselves and detailed rules on how to calculate capital requirements.
While the Basel group is weighing different options for change, it made clear that the status quo is not an option, saying a “strengthened framework” is needed.
Change is necessary to remove incentives for banks deliberatively to shift assets between their banking book and trading book to exploit differences in capital rules, the regulator said.
Such “capital arbitrage” could arise because the Basel committee already sets binding capital charges for assets banks intend to trade.
Capital is a measure of banks’ financial strength, in other words of a firm’s ability to take a hit without failing. Capital requirements dictate how far banks must fund themselves through equity and other sources that can absorb unforeseen losses.
Types of interest-rate risk in the banking book include banks getting a relatively low interest rate on long-term investments such as mortgages, while being under competitive pressure to offer higher rates to depositors. Others include banks being caught out by changes in the relationship between interest rates on short- and long-term debt.
The Basel committee brings together regulators from 30 nations to set bank capital requirements. In addition to the ECB and the Fed, its members include the Bank of England, the Bank of Japan and the Swiss National Bank
(Bloomberg) People’s Bank of China Governor Zhou Xiaochuan has been pursuing a market-based interest-rate system for over a decade. He’s almost done. Now comes the hard part.
From overnight interbank borrowing to long-term bank lending rates, there are no longer restrictions on the price of money in China. The remaining regulatory sanction that banks can’t offer savers rates more than 150 percent of benchmark deposit levels will be lifted by the end of 2015, according to the timetable made public by Zhou himself.
So the rules are now largely in place for credit to flow through the economy based on potential returns. That’s a sharp contrast to the days when Zhou took over the central bank in 2002 when Alan Greenspan was Federal Reserve Chairman and the price and flow of money in China was largely decided by the PBOC. The task now is to translate the new rules to reality.
“Zhou’s interest-rate liberalization push is approaching its end,” said Yao Wei, a China economist at Societe Generale SA based in Paris. “But it’s the beginning of the end, it’s not the end itself.”
Bloated, corruption ridden and debt burdened state-owned enterprises need implicit government guarantees revoked, so banks no longer view them as safer bets than riskier, more nimble private enterprises. Consumers need to be coaxed to borrow and spend more, to fill the gap as investment wanes.
Progress on those fronts is slower.
“A key element in interest rate liberalization is that market players have to be sensitive to prices,” said Gu Ying, vice president of Asia local market research with JPMorgan Chase & Co. in Hong Kong, who previously worked for the PBOC. “However, state enterprises and local governments are still not very sensitive to prices, and that’s a problem the central bank alone can’t solve.”
Then there’s the capital account — the flow of money across China’s borders. For a truly liberalized interest rate setting, companies and individuals need to be able to move cash more easily, with all the economic volatility that entails.
“A freer interest-rate system can help foster a market-based financial system at home, and this in turn can help capital account opening,” said Zhang Bin, an economist with the Chinese Academy of Social Sciences. “But is China really ready for full capital account opening? The answer will be ’no’ partly because the exchange rate system is not liberalized.”
Zhou has stepped up his push this year. He started a deposit insurance program to protects savers; he’s twice raised a cap on what lenders can pay savers; and this month came certificates of deposit — instruments that allow banks and savers to meet on interest rates independent of PBOC benchmarks.
Zhou’s tenure spanned the three government administrations of premiers Zhu Rongji, Wen Jiabao and Li Keqiang, the last of whom assumed office in 2013 during a once-a-decade leadership transition. The acceleration of reforms suggest Zhou has “decided to seize the moment” politically, Andrew Batson, China research director at Beijing-based consulting firm Gavekal Dragonomics, wrote on his blog last week.
For China, freer interest rates promise to make savers wealthier, aiding the economy’s transition to a more services and consumer driven economy. Private enterprises will have better access to capital, meaning the most productive forces get the money they need to expand. And wasteful, uneconomic investment by state-backed firms should become less common.
The challenge is to make those potential gains a reality.
“China’s interest-rate liberalization is almost done, but the financial system liberalization is far from over,” Zhang of CASS said. “There are borrowers taking whatever costs because they don’t have to worry about repayment. There are banks making loans on political considerations. And there are other problems. But the progress can’t be denied.”
Bond traders have a long-running reputation for being more pessimistic than their stock market counterparts and it looks like that disagreement is becoming more pronounced.
The ratio of rates volatility to equity volatility is at a post-financial crisis high, according to a new note from Deutsche Bank’s Chief International Economist Torsten Sløk.
The difference between the MOVE Index, which measures swings in U.S. Treasuries based on options prices, and the Chicago Board Options Exchange Volatility Index, a gauge of future turbulence in U.S. equities, reached its highest level since 2008. In other words, the U.S. government bond market have been pretty jumpy while stocks (as measured by the Vix) have been kind of meh.
This has been the case for much of the year, and Sløk says there are two key reasons that rates volatility has moved up while equity volatility hasn’t. For a start, uncertainty over when the Federal Reserve might raise interest rates is having an obvious impact on the Treasury market. Secondly, that impact is becoming more pronounced thanks to a lack of liquidity in the U.S. bond market.
Sløk goes on to argue that equity investors might want to worry a bit more about the Fed and its monetary policy actions.
Although many of the people he speaks with believe stocks will do well when rates finally do rise (since they’ll presumably be rising as the U.S. economy improves), he says that might not be the case.
The risk to equities is not problems from a bottom-up perspective but rather what the normalization in fixed income will mean for equities. The key question investors need to think about is the following: What comes after the seven-year carry trade we have had in fixed income and what is the impact on equities of the normalization that is coming in rates and spread product? If we have a violent adjustment in rates and rates vol and credit spreads then it is difficult to see how equities can perform well in that environment. The bottom line is that the risk to equities is not only the risk of a recession but also the risk that the normalization in fixed income spills over to equity markets.
His conclusion is that either rates markets are right in the assumption that the Fed’s first rate increase will be volatile or equity markets are right that it’s a non-event.
Whatever the case, Sløk says, the ratio of the MOVE to VIX will likely to be moving closer to its long-term average pretty soon.
Low interest rates, increased globalisation and the impact of stricter regulation have all contributed to producing a global banking industry that is perhaps more competitive than ever before.
Understandably, such a competitive landscape will force some market participants to focus on short-term survival and profitability rather than long-term sustainable practices.
Of course, banking practices will remain driven primarily by commercial considerations around risk and opportunity calculations, yet with the increased risk and proximity of natural resource shortages threatening economic growth and business profitability, sustainability now has a growing weight in reaching these assessments.
As such, a shift is taking place in the banking industry. While banks have been supporting sustainable initiatives for more than 20 years – by financing sustainable energy projects, for example – banking involvement in sustainable trade is now going further. Today, there is far sharper focus on how goods and services are produced and delivered, and banks are placing significant pressure on themselves to ensure that they check trade-related transactions for environmental, social, ethical and governance considerations.
The Reserve Bank of India (RBI) has cut interest rates for the third time this year to help boost growth in Asia"s third largest economy.
