“We are very optimistic about Iraq over the next three to five years.” It will have “considerable wealth” from its oil exports and is poised to invest in the oil and gas industry, power generation and housing to boost growth. “Over the last year, Iraq’s security situation has improved very steadily.” Over a longer period, Citigroup may have “branches, a consumer business, a middle- market business” as well as a “full-service bank in the country.”

See also: IMF: “Iraq has maintained macroeconomic stability under difficult external & internal circumstances…” and Foreigners can own 100% of Iraqi companies, pay 15% flat tax, & take all profits home.

Positive factors

Banks in the UAE are well capitalised. The capital-adequacy ratio stood at 20.8% at the end of 2010. This is well above the Central Bank requirement of 12% (and the Basel II requirement of 8%). A high capital-adequacy ratio can be perceived as a cushion to cover risks that banks may incur in their lending and financing operations.
We expect most banks to have provisioned for the bulk of the write-downs in 2010. Although we may see further write-downs this year, we expect bank lending to resume at a moderate level.

Negative factors

Further defaults by Dubai government-related entities would put banks under considerable financial strain.

Some UAE property companies have significant direct exposure to regional real estate markets such as Egypt. The unrest that has swept the region may increase the risk of default and poses a threat to banks that have lent to these property companies.

You can request the full assessment from us.

The Basel II bank-capital rules took over a decade to design and were discredited even before some countries had implemented them. The new Basel III rules, whose final version was published Thursday, were agreed to in just over a year and should provide a far more solid underpinning to the global financial system, but only if they are quickly introduced and rigorously enforced around the world. That’s still uncertain.

The rules are broadly unchanged from those agreed to at November’s Group of 20 summit in Seoul. Banks will be required to hold more and better quality capital, including countercyclical capital buffers, taking the minimum core Tier 1 ratio to 7%. [TF21's Al Rio: the 7% figure comes from a "minimum common equity plus capital conservation buffer" of 4.5% + 2.5% to enter into effect in 2013; minimum core Tier 1 is now at just 2% of risk-weighted assets, and is defined differently than it was in Basel II.]

They also must meet tough new liquidity ratios and will be subject to a leverage ratio. Had these rules been in force at the end of 2009, the world’s largest banks would have faced a combined €577 billion ($763 billion) capital shortfall and would have had a shortfall of liquid assets of €1.3 trillion, according to a study published alongside the new rules.

But it is hard to read too much into these numbers because the study makes no allowances for action taken by banks since the end of 2009 or that might be taken in the future to reduce the impact of the new rules. Nor does the study allow for earnings growth.

Indeed, the Basel Committee notes the same banks reported combined profits of €209 billion in 2009. [...]

The greater challenge is likely to lie in the new liquidity rules. The Basel Committee found that 67% of large banks had a stable funding ratio above 85% at the end of 2009, well below the new minimum of 100%, and that these banks had a combined shortfall in liquid assets of €2.3 trillion. That is potentially worrying given the difficulties some banks continue to face in accessing wholesale funding markets, difficulties that could intensify in 2011 as central banks attempt to withdraw emergency liquidity facilities.

But what matters now is how effectively the rules are implemented. One concern is the discretion Basel allows banks and regulators to use their own models to calculate risk weightings, something the Basel Committee accepts has undermined confidence in banks. It promises closer scrutiny to ensure consistency. Investors also will question why European regulators continue to allow euro-zone government debt to be zero risk-weighted now that European leaders have acknowledged the possibility of sovereign default. [NB: emphasis added]

Above all, regulators must never forget the lesson of Basel II: Banks always will find ways to game the rules, no matter how painstakingly designed.

Let me add as a personal note other issues we cannot (at least yet) model well, so we don’t know and won’t know the net effect of the rules for many years. Just from the top of my head:

• any reduction on bank profitability makes bank failure more likely, and these new standards will force the banks to lend less and to earn less;
• to prevent this reduction, at least some banks will likely behave in more risky ways, increasing the likelihood of crises.

There are many other worries of a different order. Just as an example, the IT systems and personnel expertise to fulfill the regulator’s duties under Basel III is not readily available in developing countries, and some would say not even in some euro countries, like Greece or the soon-to-enter the eurozone Baltic republics. This happened too with the previous set of rules, Basel II.

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Al Rio, contributing editor