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The New Regulatory Framework for a Post-Crisis Financial System: Priorities for the Middle East

The New Regulatory Framework for a Post-Crisis Financial System: Priorities for the Middle East. Andrew Cunningham Presentation to the Fourteenth Annual Meeting of Middle Eastern and North African Bank Chief Executives Organised by the IIF and Emirates NBD Dubai, 17-18 October 2011.

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The New Regulatory Framework for a Post-Crisis Financial System: Priorities for the Middle East

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  1. The New Regulatory Framework for aPost-Crisis Financial System:Priorities for the Middle East Andrew Cunningham Presentation to the Fourteenth Annual Meeting of Middle Eastern and North African Bank Chief Executives Organised by the IIF and Emirates NBD Dubai, 17-18 October 2011

  2. International Financial Sector Reform Banking Sector (1), strengthening existing structures • Basel III: capital, liquidity and macro-prudential oversight Banking Sector (2), new areas of regulatory focus • Global Strategically Important Financial Institutions (G-SIFIs) • Resolution of failed banks • Bankers’ pay Broader financial system (bank and non-bank) • Regulation and de-risking of “shadow banking” system • Much trading in derivatives to be moved onto formal exchanges Structures of financial regulation • New relationship between central banks, bank supervisors and financial sector stability • Strengthened powers for supra-national bodies (e.g. CEBS becomes European Banking Authority and Financial Stability Forum becomes the Financial Stability Board.)

  3. Public Policy Issues Avoid taxpayers having to pay for bank failure Bailing out banks is expensive, so we need to reduce likelihood of bank failure by strengthening banks, re-aligning the incentives/motivation of those who work in banks, and ensuring that when banks do become insolvent/illiquid they can be wound down in an orderly manner which minimises the cost to the taxpayer. Ensure banks continue to facilitate economic growth If banks are weak, the flow of credit into the economy will slow and economic growth (and prosperity) will be compromised.

  4. Public Policy Issues (Middle East) 1. The reform of financial systems in the west is being driven by the need to prevent the financial system straining government finances and/or causing economic recessions… …In the Middle East, the financial system does not represent such a threat to national governments because it is smaller as a proportion of national economic activity. Furthermore, bank bailouts are funded from government resources without the need to increase or introduce taxes. 2. In the west, the focus is on de-risking/constraining financial sector activity while trying to ensure that financial institutions continue to be able to facilitate economic growth… …In the Middle East, the focus needs to be on building large, efficient and diverse financial sectors which will promote economic growth.

  5. After the Global Financial Crisis: Agenda for Financial Sectors in the Middle East • Continue to promote reform and development of financial sectors • Respond to specific challenges presented by the global financial crisis in the Middle East • Take advantage of the work/thinking being done on financial markets following the financial crisis, and selectively adopt the the re-regulation agenda.

  6. Financial Sector Development in the Middle East Still trying to emerge from legacies of the past Enlarging and strengthening existing financial system f All six GCC countries Jordan Lebanon Morocco Palestine Tunisia Algeria Egypt Iraq Libya Syria Yemen

  7. Domestic Credit extended by banking sector % GDP (2010)* Arab World 32% Latin America and Caribbean 71% East Asia and Pacific 133% South Asia 68% Sub Saharan Africa 82% European Union 160% * Source: World Bank

  8. Reform and Development Agenda for Middle East Financial Markets Ownership Privatise banks and insurance companies Human and other non-financial “capital” Upgrade skills of staff through training; upgrade I.T.; and upgrade physical infrastructure such as bank buildings Financial ecosystem Diversify financial market through introduction/strengthening of non-bank financial institutions such as leasing companies, consumer credit companies, small-cap stock exchanges Market & legal infrastructure Improve credit bureau coverage; standardise contracts; strengthen legal infrastructure

  9. Respond to specific challenges presented by global financial crisis Losses on mark-to-market securities: 2008/09 was not the first time GCC banks have lost large amounts of money investing in securities issued and sold by western banks. Shortage of dollar liquidity: central banks need mechanisms to inject liquidity into banking system Regional co-operation: risk of capital flight due to uncoordinated action by monetary authorities Deposit insurance schemes: need to be formalised, rather than based on blanket, and sometimes temporary, guarantees. Losses on real estate – more a result of excess liquidity arising from high oil prices than the global financial crisis; but a continuing problem in the Gulf due to lack of economic diversification.

  10. Adopting the Reform Agenda (1) Banking Sector: New Areas of Regulatory Focus Enhanced scrutiny of systemically important financial institutions But issues of SIFIs not as important in Middle East as in Western markets because banks are smaller relative to GDP and less complicated/interconnected. Resolution mechanisms Banks do fail in the Middle East, so requiring banks to have some form of resolution mechanism would be beneficial. “Banks are already discovering things about themselves that they did not know.” FDIC official speaking about U.S. banks writing “living wills.” Deposit insurance Should be formalised rather than exercised through blanket guarantees by Ministries of Finance 1. The reform of financial systems in the west is being driven by the need to prevent the financial system bankrupting governments and/or causing economic recessions… …In the Middle East, the financial system does not represent such a threat to national governments because it is smaller as a proportion of national economic activity. Furthermore, bank bailouts are funded from government reserves without the need to increase or introduce taxes. 2. In the west, the focus is on de-risking/constraining financial sector activity while trying to ensure that financial institutions continue to promote wider economic activity… …In the Middle East, the focus needs to be on building large, efficient and diverse financial sectors.

  11. Adopting the Reform Agenda (2) Broader financial system: bank and non-bank Significant factor in the global financial crisis was that market participants and regulators misunderstood how the financial system had evolved: * the size of non-bank financial activity: In early 2008, the “shadow banking system” in the U.S. was $20 trillion, vs $12 trillion for the banking system * the fluid dynamics of financial transactions (e.g. trapped cash, collateral calls, marks, effect of rating downgrades on liquidity and price.) As financial markets in the Middle East develop, participants and regulators need to continue to understand how the loci of financial market activities are changing and how the fluid dynamics would work under stress

  12. Adopting the Reform Agenda (3) Changes to financial regulation Scope e.g. Under the Dodd-Frank Act the Federal Reserve has oversight of systemically-important non-bank financial companies and may impose prudential standards on such companies. e.g. U.K. Financial Conduct Authority supervises firms which fall outside the scope of the new Prudential Regulatory Authority Structure Creation of new bodies to focus on macro-economic risks (Financial Stability Oversight Council in U.S. and Financial Policy Cttee in U.K.) Mandate U.K.’s Prudential Regulatory Authority (successor to FSA) has a macro-prudential/financial stability remit as well as a micro-prudential. Will also oversee insurance companies.

  13. The “Arab Spring” and Financial Sector Reform “Governance” is a key theme of the “Arab Spring.” In the political sphere, citizens are demanding more transparency and accountability in the way they are governed. The financial sector should continue to set an example in this area. “Arab Spring” likely to divert time and resources away from financial sector reform as political issues take precedence. Privatisation will be postponed. Short and medium term: the “Arab Spring” will place strain on government budgets as welfare payments are increased.

  14. Biggest banks (by asset size) % GDP(2010) Biggest banks in GCC Assets % home country GDP* Biggest banks in the World Assets % home country GDP 1. BNP Paribas 104 2. Deutsche Bank 77 3. HSBC Holdings 109 4. Barclays 104 5. Royal Bank of Scotland 101 6. Bank of America 16 7. Credit Agricole 83 8. JPMorgan Chase 15 9. ICBC (China) 35 10. Citigroup 13 11. Mizuho Financial Group 34 Unicredit 61 1. Emirates NBD 34 2. Nat. Commercial Bank 17 3. Qatar National Bank 62 4. Nat. Bank of Abu Dhabi 25 5. Samba Financial Group 11 6. Nat. Bank Kuwait 42 7. Al-Rajhi 11 8. Abu Dhabi Comm. Bk. 21 9. Riyad Bank 11 10. Kuwait Finance House 41 Arab Banking Corp. 136 Bank Muscat 33 Nat. Bank of Bahrain 29 * 2009 GDP for Bahr, Kuw, Oman and UAE

  15. Other Middle Eastern Banks % GDP Assets % home country GDP (end 2010) National Bank of Egypt 24 Commercial International Bank 6 Arab Bank 185 Audi Saradar 73 BLOM Bank 57 Attijariwafa 40 BanqueCentralePopulaire 28 BMCE 19

  16. GCC commercial banks ranked by equity size (1) End-1994 End-2010 1. Emirates NBD 2. Nat. Commercial Bank 3. Al-Rajhi 4. Nat. Bank of Kuwait 5. Riyad Bank 6. Samba 7. Qatar National Bank 8. First Gulf Bank 9. Nat. Bank Abu Dhabi 10. Kuwait Finance House 11. Abu Dhabi Commercial Bank 12. Saudi French Bank 13. Alinma Bank 14. Arab National Bank 15. Saudi British Bank 1. Nat. Commercial Bank 2. Riyad Bank 3. Arab Banking Corp 4. Nat. Bank of Kuwait 5. Al-Rajhi 6. Nat. Bank of Dubai 7. Samba 8. Saudi British Bank 9. Saudi French Bank 10. Arab National Bank 11. Qatar National Bank 12. Gulf International Bank 13. Nat. Bank of Abu Dhabi 14. Gulf Bank (Kuwait) 15. Burgan Bank

  17. GCC Commercial Bank ranked by equity size, (2) • Biggest 30 GCC banks (by equity) in 1994 all still exist in 2011, with the exception of three which have been absorbed into larger institutions. But those three were “underperforming” not “failed” banks. • Of 65 GCC commercial banks in existence in 1994, only about 8 brand names have disappeared.

  18. Stock market capitalisation % GDP (2010) Jordan 112 Qatar 89* Bahrain 82* Saudi Arabia 81 Morocco 76 UAE 48* Egypt 38 Oman 37* Kuwait 32* Tunisia 24 * 2009 Source: World Bank United Kingdom 138 United States 118 France 75 Japan 75 Germany 43 Italy 24 Hungary 20 Poland 17 Czech Republic 7 Slovak Republic 7

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