Make banks pay for risk: IMF

BIG banks with a serious mismatch between their asset and liability maturities could be forced to pay a surcharge or take out insurance against the risks they pose to the financial system, the International Monetary Fund has suggested.

In a review of the October 2008 liquidity crisis that forced governments to guarantee trillions of dollars of bank debts not least in Australia the IMF calls for wide-ranging reforms to reduce systemic liquidity risks in future.

The proposals were revealed overnight in a chapter released early from its Global Financial Stability report, to be published next week at the annual meetings of the IMF and the World Bank in Washington.

The IMF singles out the Australian banks as examples of financial institutions that lent long term but borrowed heavily short term and then were stranded in October 2008 when lenders would not roll over their debts.

At the onset of the crisis, it says, 32.2 per cent of Australian banks' funding came from short-term borrowings, on domestic and global markets. While the banks used the period of the government guarantee to diversify their funding sources and lengthen their maturity structure, at the end of 2009, 25.6 per cent of their funding was still short term.

"Any robust systemic liquidity framework would need to encourage appropriate pricing of liquidity risk in good times to limit its negative impact in times of market stress, and minimise the moral hazard problems", the IMF argues.

"Market participants should be paying the full price of their idiosyncratic liquidity risk".

It urges consideration of an insurance fee or surcharge where the mismatch between asset and liability maturities exceeds a set safety limit.

The IMF also proposes bigger buffers against risk, tighter matches between maturities on each side of balance sheets, more rigorous valuation of collateral and due diligence into the credit risks posed by counterparties, and more use of central counterparties for clearing.

In a second chapter from the report, the IMF also takes on the three global credit ratings agencies Fitch, Moody's and Standard & Poor's calling on them to issue estimates of the probability of default and expected losses by borrowers.

Amid widespread concern, particularly in Europe, over the ratings agencies' failure to warn of the crisis, and of the contagion effects of their downgrades of one country on others, the IMF finds the agencies have done better than their enemies suggest but worse than their own guidelines suggest.

On one hand, it reports, all sovereigns that have defaulted since 1975 were rated below investment grade a year earlier.

On the other hand, the record shows almost one in 1000 corporate bonds given AAA ratings by Moody's has defaulted, roughly 30 times its own estimate of default probabilities.

The IMF urges government investment agencies and central banks to eliminate regulations that "hard-wire" their investment portfolios to ratings changes, warning that these tend to amplify the "cliff effects" of a change on the borrower's access to credit.