1

1

E-mail Article

Printer Friendly

Share Article

Analysing potential disasters

No one wants to think about worst case scenarios while business is booming, but some are already considering what could happen in the event of a major bank collapse in the Middle East.

Moody's recent incorporation of Joint-Default Analysis (JDA) into bank ratings takes into account the likelihood that a bank would be supported by its parent or national government if it defaulted.

Mardig Haladjian, senior VP, banking, Moody's Investors Service, says: "We had been imputing possible support in the past. Now we have to explain our assessments more clearly because of the joint default concept. The rating outcome imputes an implied probability of support."

The joint default concept argues that in order for a creditor to lose the money they lend to a bank, both the bank and its supporter (its parent or national government) must fail to pay. If the government of a country is strong, its banks are likely to receive a higher rating.

The ratings of several banks in the Gulf have been upgraded under the new rating system, as Haladjian says Moody's assesses a high probability that banks in the GCC would be supported in the event that they ran into difficulties.

However, support need not necessarily be a commitment to repay a bank's liabilities. "Support can take different forms - the government can make a statement that a bank's deposits are guaranteed," explains Haladjian. "It is usually less costly to support a bank from the start than to let it suffer a run on deposits and then pick up the pieces when things go horribly wrong."

Central Banks can assist in the event of a liquidity crisis, and Haladjian points out that once a month one of the Central Banks in Asia requires everyone in the department to rehearse the role they are required to play in an emergency.

"Being ready and having thought about it is 90% of the work," he says. "The Gulf states don't tend to have that level of readiness. If and when [a financial emergency] happened, success would depend on the persons who handled it."

There is a difference, though, between ability to support and willingness to support. "The ability to support is stronger in the GCC, as reflected in the local currency deposit ceilings" Haladjian says.

He adds: "Willingness remains strong in other Middle East countries as well, but this may mainly depend on non-fund support means."

However, there usually is a cost to bailouts for banks' shareholders as well. If banks are confident that they will be bailed out by the government if they get into difficulties, it could encourage them to adopt high risk, high yield strategies.

"If they tell you they'll support you no matter what, you'll probably take more risks," says Haladjian. "That's why support is not guaranteed."

Haladjian says that the Islamic banking sector, despite its status as an emerging industry, could in fact prove more resilient than conventional institutions. "Their activities are largely asset-based, so in that sense you could say their position is more secure than some other banks in the region," he says.

He adds: "I don't see any reckless behaviour on the part of banks. They do try to diversify their risks. One can say they are doing their part."

As with any emergency measures, it cannot be known for certain what actions will be needed, and which will be successful. The true test will come if - or when - the Gulf sees its first bank failure in the modern age.

Comments 1-1 of 1