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Rating errors 'caused global financial crisis'

Manama, January 10, 2011

A lack of risk management and rating agencies that gave triple A ratings to assets which were garbage were the real cause of the financial crisis, an expert said.

That, more than the excesses of banker, were the cause of the meltdown, Bahrain Association of Banks chief executive officer Robert Ainey told members of the Rotary Club of Manama at a lunch at the Gulf Hotel yesterday.

'Some people suggested that the Islamic finance industry managed to avoid the downturn faced in the West because they had not invested in products like derivatives and subprime mortgage-backed structured vehicles,' he said.

'But as Central Bank of Bahrain (CBB) Governor Rasheed Al Maraj pointed out at the Islamic banking conference in Bahrain in 2008, Islamic banks were also hit because cheap liquidity in the region and massive over-leveraging allowed them to become massively exposed to one asset class - real estate.

'This should not be surprising because high returns require high risks, and the high returns achieved by Islamic banks could only be generated by taking on a corresponding degree of risk,' he said.

'It is worth recalling the quite exceptional returns that some Sharia-compliant financial institutions managed to achieve in the decade prior to the financial crisis.

'Assets doubled almost every two years, while net income doubled every year. Some institutions were able to earn a return on equity of more than 30 per cent and in some cases even more than 40 per cent. They were also able to earn an average return on assets approaching 10 per cent,' he said.

'Excessive risk-taking was encouraged by an environment of cheap and plentiful liquidity, which meant that conventional as well as Islamic financial institutions could massively increase their leverage.

'Overall, the ratio of capital to total assets in conventional banks fell by almost half in the 10 years after 1997. Much bigger balance sheets were being supported by the same amount of capital. The effect of this increased leverage was, of course, to boost the return on equity.

'Higher returns came with higher risk,' Ainey said.

'As the CBB Governor pointed out, it is no longer wise to base business models on the hope that the era of cheap and plentiful liquidity will soon return.

'The industry and regulators need to recognise that the crisis has produced a fundamental change in the global financial system. One clear result has been to make participants in the global financial markets much more cautious and risk-averse.

'There now seems little doubt that the days of cheap and abundant liquidity will not return for the foreseeable future,' he said.-TradeArabia News Service




Tags: Global economy | Financial crisis | meltdown | rating agencies | errors |

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