Once again the politicians, bankers and businessmen are gathering in Davos, Switzerland, for the World Economic Forum. Last year there were few bankers around the plush ski resort. Most were still back in their offices fighting the financial inferno caused by worthless assets that they had sold to investors and each other as top-rated investments.
Last year therefore the nervous talk was all about what had gone wrong and how the fires of recession could best be quenched. This year, as it seems the worst is over, the debate is moving to the regulation of a new world financial order which it is hoped, (probably against the odds), will stop bankers from ever being so greedy and foolish again.
Because politicians with angry electorates are likely to be driving the debate, the bankers will be defending against what they will regard as punitive measures, such as the determination of some leaders, including President Barack Obama, to break up big banks which at the height of the crisis were regarded as too big to fail.
The political agenda may not however be the most useful approach to finding a new and effective regulatory framework. Amidst all the grandstanding and huffing and puffing for electorates back home, the danger is that the debate at Davos may overlook the extremely simple way of curbing a further firestorm of toxic assets. This is that all assets are transparently represented on the balance sheets of financial institutions.
There, however, the simplicity ends. There is currently a major dispute about how the so-called “fair value” of an asset can be measured at any particular time. The International Accounting Standards Board, after wide consultation has produced a new standard (IFRS 39) on financial instruments. The EU commissioners have blocked its implementation for their banks and companies, pending detailed assessment of the new rules. The US Generally Accepted Accounting Principles (GAAP) meanwhile has a different standard. Hopes that the two definitions could be melded so any bank’s balance sheet could provide the same quality of information, are being threatened by the EU’s action.
Brussels has acted because the tighter definition of asset values threatens the capital position of some major European banks. Under the Basel capital adequacy rules of the Bank of International Settlements, (BIS) certain asset classes can be counted toward capital. Taken with an expected increase in the amount of free capital every bank must have, a tougher new accounting regime is going to cause many problems to financial institutions. In essence if a country’s banking system is forced to shrink its lending, it will also shrink the economy and GDP. Business is already suffering from limited credit. The new BIS capital requirements coupled with a more transparent accounting standard threaten recovery from recession.
Yet there is no better time to take the pain of change than now. Once economies pick up again, there will be all sorts of good reasons why new standards are not really necessary. Therefore everyone at Davos needs to focus remorselessly on promoting unified and detailed change across the banking sector.
