|
Melbourne APEC Finance Quarterly Issue 9, August 2010
|
|
|
||
|
|
Welcome to the newsletter of the Melbourne APEC Finance Centre. In introducing our 9th edition, we are firstly pleased to advise our readership that, following a recent performance review, the Australian APEC Study Centre at RMIT’s College of Business, has substantially met or exceeded all of its key performance indicators, and as a consequence of the review, RMIT University has decided to extend it’s association with the Centre for a further five years. In this newsletter, John Conroy of the Foundation for Development Cooperation looks at financialization of microcredit today; Rowan Dowland of mecu Limited informs how the credit union, has turned sustainability into a key business strategy; Principal Advisor of Financial Risk Management at KPMG Bruce LeBransky examines the regulatory reform proposals raised at G-20 in Toronto, and APEC Study Centre Director Ken Waller, in his regular column, tells us about the results of the recent Capacity Building program held by the Centre in Shanghai, China in early June. FINANCIALIZATION AND MICROCREDITJohn D Conroy is Special Consultant at the Foundation for Development Cooperation. He has participated in ABAC’s Advisory Group on APEC Financial Sector Capacity-Building
Another kind of Subprime Lending? Since the 1980s, when Grameen Bank emerged, thinking about financial services for the poor has undergone considerable evolution. In the beginning, Yunus pioneered straightforward micro-lending, funded by donors. During the 1990s emphasis shifted to ‘microfinance’, seen as offering a range of services to the poor. These included deposits, transfers, remittances, even micro-insurance, in addition to credit. More recently the concept of ‘financial inclusion’ has taken hold. This refers to the need to provide access to formal financial services for all. In the meantime, however, pure micro-lending operations have continued to grow in the marketplace. The arrival of a new class of for-profit investors, both foreign and domestic, is transforming the industry, which had been largely the province of non-profit entities. Investors are attracted by high interest rates the poor are prepared to pay and the low level of non performing loans of well-managed ‘MFIs’ (microfinance institutions). The financialization of microcredit The financialization of micro-lending has taken forms familiar from mainstream capital markets, including creation of specialized ‘microfinance investment vehicles’ (MIVs) and the use of securitization, collateralized debt obligations and structured finance, among other risk-management tools. Examples abound of credit wraps or guarantees, loan syndications and hedging mechanisms. Specialized services, including ratings agencies, support the industry. Substantial (and highly successful) share floats are beginning to occur, pointing the way to ‘exit’ opportunities for private equity investors and increasing the allure of for-profit investment. Microcredit in developing countries has become a new asset class. Data provided by the ‘Consultative group to Assist the Poor’ (CGAP), a World Bank affiliate, suggest that at end-2008 the return on assets for MFIs in many developing countries was higher than for commercial banks. Some 75% of MIVs dealt entirely or mainly in fixed interest investments. While some were ‘socially focussed’ and accepted lower returns, others offered ‘structured’ products with a range of risk/return options. Overall, the average gross yield on debt held by MIVs was a respectable 9.5%. Other MIVs were private equity funds taking stakes in micro-lending operators. This newest class of investors had the highest rate of asset growth among MIVs. More than 100 MIVs in operation at end-2008 held total funds under management of some $6.6 bn. They recorded asset growth of 72% in 2007 and 31% in 2008.Equity holdings of MIVs were growing even more rapidly, by 47% in 2008. In aggregate, foreign capital commitments to MFIs from all sources were estimated to total $14.8bn at end-08, divided almost equally between aid donors (48%) and investors (52%). Financialization and its discontents Negative impacts of this financialization include looming credit and private equity bubbles in at least one of the most ‘advanced’ micro-lending markets, India. There, according to a CGAP/JP Morgan analysis, MFI equity deals are being done at up to six times historical book value. This will surely have negative consequences for over-indebted households and excessively-leveraged institutions. But even more damaging, in the longer-run, is the neglect of domestic savings mobilization that financialization engenders. Access to investment funding disinclines MFIs from seeking deposit-taking status, or from exploiting that status fully. Many find it easier and cheaper to rely on external resources than to mobilise savings. At the systemic level, when financial institutions are ineffective in mobilizing savings, financial intermediation is hobbled. Effective domestic intermediation contributes to financial deepening and supports financial development. Local deposit mobilization is a platform for grassroots financial development, while greater reliance on deposits reduces MFIs’ vulnerability to external shocks. Growing reliance on external resources may void these benefits. Recent rapid growth of micro-credit lending appears to have proceeded without corresponding growth in MFI deposit mobilization. USAID reports a major change in composition of the liabilities of an international sample of MFIs. Between 2004 and 2007, the balance changed from 92% deposits and 8% debt, to only 45% deposits and 55% debt, despite an increase in the proportion of deposit-taking institutions. This is not balanced financial development. For households, absence of deposit facilities denies important benefits to the self-employed poor, including vital learning processes and the opportunity to acquire financial ‘identity’. Savings offer them a buffer against misfortune, permitting consumption smoothing, as well as management of lumpy income flows. To the extent that it neglects or represses savings, investment in micro-lending does nothing to meet this complex bundle of needs. Foreign investment: pro and con Neither commercialization nor for-profit foreign investment will necessarily repress financial development or distort MFI operations. Commercialization is a necessary condition for building sustainable grassroots financial services. Since capital shortage is a defining feature of underdevelopment, some level of foreign investment should be welcome. Foreign investors may bring positive technology ‘spill-overs’, to the benefit of domestic MFIs. Foreign investment might discourage domestic investment in MFIs, but it might also prove complementary to it. But the telling objections flow from negative consequences described above: repression of domestic savings and denial of deposit services. Worse, MFIs receiving foreign commercial funds will often experience ‘mission drift’. They may be pressed to meet investors’ performance benchmarks, causing a focus shift from the poor to middle-income clients, and to consumer durable lending rather than livelihood financing. Some level of funding from domestic investors should benefit MFIs, via technology spill-overs and mutually beneficial operating linkages. There are many advantages in borrowing from local banks. Loans are generally in local currency and such banking relationships may grow deeper over time. Alliances with commercial banks may promise MFIs financial services they cannot themselves provide, including savings or ATMs. However, if domestic for-profit investment causes mission drift, or if it represses savings in particular sectors or social strata, there are compelling reasons to object. Conclusion: financial inclusion and ‘distributed’ finance The adoption of financially-inclusive policy frameworks may offer poor societies an escape from contradictions posed by foreign-funded micro-credit, as will efforts to create ‘distributed’ financial institutions and systems. Distributed financial systems may provide foundations for improved financial inclusion. The concept is one of a financial ‘microgrid’, with self-sufficient local power centres, drawing capital from local communities, in which MFIs would be prominent. Distributed institutions, growing through savings accounts and local capital markets while offering responsible lending, could underpin a diversified and durable financial system. For MFIs in developing countries, this model poses a credible alternative to current pre-occupations with cross-border financing. ABAC would do well to comprehend this alternative, among whatever others it considers, in its campaign for ‘financial inclusion’ in APEC economies.BANKING ON SUSTAINABILITYRowan Dowland is General Manager Development at mecu Limited
The road to responsible banking mecu began as a small banking co-operative in Victoria more than fifty years ago. It is now a flourishing national organisation with assets of more than $2.4 billion and some 140,000 members across Australia. In the hard nosed world of finance, it is interesting that this credit union has embraced sustainability as a core value and business strategy. It has re-focused its internal processes, developed responsible products and features and has carved out a niche in areas like affordable housing. mecu is working closely with the affordable housing sector and is investing its owners funds in financing the development of affordable housing projects across Australia. Moreover, the credit union plans to become carbon neutral by 2011. It is contributing to environmental sustainability by replacing biodiversity lost during new home constructions, and carbon emissions from car loans and its banking business generally. The credit union has established a Conservation Landbank through which it acquires and revegitates offsetting tracts of prime native bushland. The Landbank is managed by Landcare Australia, in collaboration with local communities and is protected against any future development by Trust for Nature conservation covenants. Environmental management at work On the internal front, mecu has an environmental management system, and has put processes in place to manage paper, waste, energy, travel, water, land procurement and partnerships. Twenty five per cent of the electricity at its Kew, Victoria head office comes from GreenPower and in 2008 it installed a large array of solar panels on the roof of the Kew building. Water is monitored at all service centres and a 33,880 litre rainwater tank has been retrofitted at head office for watering the garden and flushing toilets. It has committed to a supply chain management system, and over time this will ensure that the suppliers it deals with also have a commitment to sustainability. One of the most significant ways the credit union believes it can make a difference is by encouraging behaviour change through its products and services. The mutual has a range of loan products and features designed to encourage borrowers to make environmentally positive choices. Examples include loans that provide reduced interest rates for fuel efficient cars, or more competitive home loan rates for purchases or retrofits of properties with a 6 star plus environmental rating. Loans features are available to assist members to pay off environmental upgrades in or around the home. Sustainability and Business Strategy Despite challenging market conditions presented by the GFC, mecu achieved a near record level of surplus and growth in 2010 and continues to deliver exceptionally high levels of satisfaction. At the same time staff engagement remains at world’s best practice levels. The Mutual believes that sustainability is an important point of differentiation, and is contributing to better business outcomes. Chief influencing factors, in its view being:
Strong interest exists both nationally as well as internationally in mecu’s approach to responsible banking. Members of the executive team are regularly invited to speak at forums including the United Nations Environmental Program and World Council of Credit Unions. G 20 AND REGULATORY REFORM FOR BANKSBruce Le Bransky is Principal Advisor, Financial Risk Management at KPMG.
The FSB remains committed to previous key timelines The statement from the Financial Stability Board (FSB), following the G20 Leaders meeting in Toronto, makes clear the timeline for detailed announcements on regulatory reform remains end-2010 (following the Seoul Summit in November) with an initial implementation date of 2012. Transition arrangements will be permissible to reflect differences in existing regulatory approaches and the circumstances of national economies. The statement provides no further elaboration as to how these arrangements will be determined. The subsequently released statement by the Basel Committee on the main design elements of the reform proposals indicates that certain components will be introduced with delay: leverage ratio disclosure will start from January 2015 and the commencement of the net stable funding ratio requirement will be no later than 2018. Neither of these statements details the new minima for regulatory capital adequacy ratios or the extent of its introduction in 2012. Member countries of the G-20 have agreed to a series of monitoring proposals on regulatory reform implementation and adherence, including thematic and country peer reviews, together with the publication of country assessments. There are issues associated with transition Transitional arrangements are common in circumstances of substantial regulatory change, but their ability to successfully mitigate adverse market reactions to perceived compliance gaps of institutions with the agreed eventual requirements is less assured. Significantly different transitional arrangements across regulatory jurisdictions, as opposed to delayed but common start dates, may also raise concerns about the meaningfulness and comparability of aggregated risk and capital outcomes reported at a consolidated group (L2) level. There is presumably a market expectation that the stress testing exercises undertaken by banks in response to regulatory requests and requirements should have been largely sufficient to capture possible revisions to the Accord, including modifications of risk-weighted asset calculations and total capital requirements. Nevertheless this may not altogether align with the experience of more recent exercises and in turn cause a questioning about the meaning of “permissible transition”. The FSB announcement restates previous comments that the quality and (minimum) amount of capital in the banking system must be significantly higher to improve its capacity to absorb losses and enhance resiliency from an institutional and financial system perspective. The expected emphasis on Tier 1 Capital and limited recognition (if any) of Tier 2 Capital for assessing regulatory capital adequacy means that decisions on the continued recognition of credit loss provisions as part of regulatory capital will also have to be finalised this year. At the same time, setting a minimum capital ratio other than the longstanding “8 per cent” may have flow-on impacts to other areas of regulation including permissible limits on large exposures and intra-group exposures. Overlaying these developments is the Basel Committee’s announcement that proposals for capital buffers will be finalised by year-end. The potential interplay of macro-economic policy issues with the regulatory requirements imposed on individual institutions will be one of the closely monitored topics in the announcements post-Seoul. The wider impacts of reform proposals – the potential to impact business models The reform proposals clearly have the potential to affect the business models and strategies of individual financial institutions. For larger banks the potential consequences would include any decisions taken on proposals to address “too big to fail” concerns including capital surcharges. Elsewhere there has appeared commentary about the likely continued willingness of regulators to accept the use of branches across regulatory jurisdictions for significant business activities and the conduct of asset-liability management as opposed to requiring the establishments of standalone and separately capitalised subsidiaries. Beyond the adjustments of existing Pillar 1 requirements, there needs to be greater elaboration of the intended balance between Pillar 1 risk measurements with Pillar 2 risk review decisions of national regulators in setting institutional prudential capital requirements. Since the commencement of the global financial crisis, there has been a greater focus on appropriate capital management decisions occurring by way of stress testing under Pillar 2 arrangements rather than the common rules and principles of the Pillar 1 requirements. Supporting this trend has been the Basel Committee’s issuance of supplemental Pillar 2 guidance including the expected involvement of Boards and senior management in implementing appropriate stress testing procedures, analysis and responses. Less obviously addressed is how Pillar 3 disclosures should capture and reflect the judgements used in and outcomes of stress testing, and what this means for the comparability of reported risk profiles and capital ratios of financial institutions within and across national jurisdictions. Consideration of and responses to differences in the funding profiles of financial institutions’ balance sheets, including a financial system’s broader dependence on (overseas) capital markets, will also impact regulatory decisions and requirements. The expectation that home regulators will be prepared to accept differences in regulatory liquidity recognition suggests a regulatory framework of more and not fewer national discretions which helps to explain the G-20’s agreement about monitoring. At the same time the emergence of the net stable funding ratio as a supervisory tool makes likely a growing business focus on the structure and term of deposit-taking and lending activities and the construct of transfer pricing procedures and its governance. Change is an On-Going National regulators and their governments continue to propose and make significant changes to their own domestic regulatory frameworks and requirements that will overlay the finally agreed G-20 regulatory reforms. These are particularly notable in areas of the market conduct of institutions and their reasonable treatment of customers. Changes in the governance practices of bank boards are also continuing with a growing focus on issues of: strategy setting and its management, reputation risk, and information technology investments. Increased training and education on issues of risk and key commercial processes is also apparent at board level. REFORMING THE REGION’S BANKING SYSTEMS IN RESPONSE TO THE GLOBAL FINANCIAL CRISIS IS PROGRESSING BUT A SUSTAINED EFFORT NEEDED TO SECURE REGIONAL FINANCIAL SYSTEMSKen Waller is the Director of the Australian APEC Study Centre at RMIT.
Further analysis and work is being undertaken by global standard setting bodies and by international and regional agencies as proposed reforms in response to the global financial crisis continue to be assessed and refined. More work is yet needed to implement effective stress testing in banking systems, in the development of surveillance and monitoring systems and early warning systems – all necessary and important components of approaches to minimize future risks to banking and financial systems. As these matters develop, the need to understand them and the impacts they will have on regional financial systems will continue to be a critical component of effective financial system supervision in the APEC region. Policy makers and regulators in the region will need to understand, analyse and be aware of the impacts of reforms as they are refined and in some cases reformulated. These issues were the subject of a major APEC capacity building training program aimed at assessing and implementing regulatory reforms in the region following the global financial crisis. The program, funded by the APEC Support Fund and with support and the Melbourne APEC Finance Centre, was conducted in Shanghai from 7/11th June, as a cooperative endeavour by the Asia Pacific Finance and Development Centre and the Melbourne APEC Finance Centre. The program was designed to enhance the understanding of policy and regulatory officials concerned with banking systems of APEC economies and other regional economies, of changes proposed to financial systems regulatory approaches as a consequence of the global financial crisis and to encourage and promote the implementation of regulatory reforms relevant to the needs of the Asia Pacific region. 24 participants attended from 11 APEC economies (China, Chile, Indonesia, Malaysia, Mexico, PNG, Peru, Philippines, Russian, Thailand and Vietnam). Another 17 officials attended from non-APEC economies, Belarus, Cambodia, Myanmar and Laos DPR and officials participated by video-conferencing to Beijing, Mongolia, Vietnam and Sri Lanka. The program considered the following issues:
Expert and specialist presenters came from regional regulatory and policy agencies (in particular the China Banking Regulatory Commission, the Australian Prudential Regulatory Authority, the Financial Research Center, Finance Services Authority, Japan, the People’s Bank of China), and from the following international and regional institutions, the IMF, the Bank for International Settlements, and the ADB. The private sector presenters came from the Institute of International Finance, the Industrial and Commercial Bank of China, Standard Chartered Bank, the ANZ Group and ASB-CBA Group. The Director of Research of the Australian Centre for Financial Studies provided expert academic input. The program identified a number of critical issues relating to proposed reforms to banking systems. Some will necessitate detailed scrutiny by regional policy makers and regulators as they consider the impact of proposed reforms on financial system stability and economic development, while others are undergoing refinement by standard setting bodies. Some the critical issues are:
The program was ambitious and it did involve discussions and considerations of complex and somewhat controversial subjects. Major banks and regional regulators do have reservations about the prospect of rising capital charges that will emanate from the implementation of reforms currently under consideration in global standard setting agencies. How far regional economies and their agencies are involved in shaping reforms is a moot point and it will remain so until more effective regional financial system architecture becomes more sharply developed. As important as the program was in providing an understanding of the causes and the basis of the reforms now under consideration and factors involved in implementing reforms, it did also provide insights into broader economic and financial matters that are shaping financial systems and the broader economic conditions that impact on systemic stability. Responding to some of the challenges just outlined will involve:
Strengthening financial policy and regulatory capacities to respond to these challenges will require sustained capacity building and training initiatives. Such initiatives ought to focus on ensuring that national policy and regulatory agencies are equipped with the policy skills needed for them to be pro-active in their supervisory duties, to build their capacities to “kick tyres” in assessing the qualities of banks’ risk management and governance approaches, and to have the skills to undertake macro-economic analytics, stress testing and crisis management, the latter requiring careful and effective coordination between national regulator and policy makers. As financial intermediaries increasingly provide cross-border services, modes of regulatory coordination between national jurisdictions is becoming a critical component of cross-border regulatory coordination. Enhanced regional financial coordination ought to be a priority matter for APEC. These are key challenges for APEC in ensuring that the region’s financial systems are robust and stable to contribute to growth and to regional integration.
|
|
