The next major financial crisis is unlikely to stem from banks blowing up but rather from problems in payments and exchange systems, senior bankers have been warned.
This was the view espoused by former Bank of England and Hong Kong Monetary Authority regulator Simon Topping when he visited Australia last week to meet leading financial institutions and regulators.
Mr Topping, who now leads KPMG’s financial services regulatory centre of excellence in Asia-Pacific, told local bankers and risk officers the capital and liquidity reforms under Basel III would go some – although not all – the way to protecting banks from collapse.
Over a lunch briefing at KPMG’s Sydney office attended by The Australian Financial Review, Mr Topping was asked by one banker where he believed the next crisis would ignite. He pointed to the so-called “plumbing" of the financial system – payments and settlement as well as clearing exchanges. His thoughts should be informed ones. Last month in Seoul, he attended a high-level meeting of banking regulators from the Basel Committee on Banking Supervision, which included the chairman of the Australian Prudential Regulation Authority,
Internationally, regulators are pushing for more financial products to be cleared by central clearing houses, including over-the-counter derivatives. This reduces the amount of bilateral trades in the system and increases protection from counterparty default.
But it also potentially introduces risks to financial stability by concentrating risk in the hands of a smaller number of institutions which stress can be transmitted between.
“Everyone is being required to clear and report through these bodies now, so there is concentration risk," Mr Topping said.
“They are not themselves subject to direct regulation."
Global regulators and the Reserve Bank of Australia, which is responsible for financial stability, are mindful of risks lying outside the banking system.
A new set of financial standards for financial market infrastructure was published last year by the International Organisation of Securities Commissions and the Bank for International Settlements’ committee on payments and settlements systems. The Reserve Bank and the Australian Securities and Investments Commission were active in the formulation of the standards, and new rules for central clearing will take effect from March 29.
While there is no licensed central clearing party for OTC derivatives in Australia at present, ASX Clear (Futures) is developing a capability to clear Australian dollar interest rate swaps and LCH Clearnet is seeking a licence to serve Australian participants.
The globally directed standards include guidance on credit risk, counterparty risk and liquidity risk. In the future, high-value payments for interbank settlements with the RBA will be covered by similar rules.
Mr Topping mentioned the payments system as a potential source of risk. One factor that should help safety is the movement towards real-time payments. Large outstanding financial commitments between institutions are now settled in close to real time and banks are working towards this for smaller retail payments.
The daily $220 billion flowing through the Australian payments system is large, but the quick settlement of payments helps to minimise systemic risk. Lightly regulated entities like Apple, Amazon, Google and PayPal are moving into the payments system. But in Australia so far, the system is still dominated by large banks, which are tightly regulated.