Bank regulation getting better, but will it be enough?

Where is the next financial crisis going to come from? This issue is always on the minds of investors. While it come from the banking sector? 

There has been a significant increase and improvement in the regulation of banks in high income countries, but the supervision and oversight for EM banks is not at the same level. These banks do not have or meet the same capital, leverage, and regulatory requirements, so there is less buffer against any financial shock. Now, this risk differential between DM and EM has always been the case, but it suggests that EM financial institutions may still be more vulnerable than DM financial firms. (See Bank Regulation Supervision a Decade After the Global Financial Crisis Global Financial Development Report 2019/2020 World Bank.)

While there is a strong agreement that the post crisis financial regulation has reduced or mitigated transmission of international shocks, there is the view that more financial activities have moved into the shadows.

There has been improvement in regulatory capital to risk-weighted assets for high income OECD countries, but developing country capital to asset ratios have stayed relatively stable. 

Countries have been meeting different regulatory standards. The high income countries have just about all reached the Basel III regime while lower income countries are still governed by Basel I and Basel II. While this is not a danger, the sensitivity to any shock will differ across countries.

Although it is not directly related to bank regulation, bank concentration continues to rise. Larger banks have the infrastructure to improve risk management, but risks are also further concentrated. 

Bank riskiness, impaired loans and provisions before and after the crisis have all moved in the same direction. The data tell a mixed story. The bank z-scores are higher, but the loans to deposits ratio is lower. The nonperforming loan to gross loans and provisions to nonperforming loans are mixed. 

While there has been a rise in leverage and overall debt globally, the actual riskiness of the banking system has declined. Nevertheless, the dispersion of supervision and regulation should be a concern especially for investors who focus on EM markets. Additionally, the greatest fear should be that risks have moved into the shadows that are not regulated.