Arab banks urged to stay away from derivatives

The Arab World’s top banker Tuesday welcomed the approval of a bill of sweeping financial reforms in the United States and urged regional banks to learn a lesson and stay away from the “time bomb” derivatives.

Adnan Youssef, Chairman of the Beirut-based Union of Arab Bank (UAB), said the more than 470 banks in the Arab World should welcome the US Senate approval of President Barack Obama’s bill for financial reforms, which will introduce widespread changes to the regulation of the US banking sector.

Youssef, also CEO of the Bahraini-based Al Baraka Bank, noted that the new US law would largely curb dealing in derivatives, which he said had been blamed by many officials and experts for the 2008 global fiscal crisis.

“Arab banks should welcome and bless this US move aimed at introducing more restrictions on the derivatives market…we have frequently warned against the dangers of derivatives, which is believed to be the main cause of the global crisis…we have cautioned that these investment instruments are only time bombs whether for dealers or for the whole economic system,” he said.

“For this reason, we urge Arab banks to be committed to real banking practices, which represent real ethics, values and principles…this means that banks should be committed to funding the real needs of individuals and institutions, investing in public and private sector projects and supporting local and global trade….Arab banks should stay away from derivatives and other financial tremors.”

The bill makes considerable and widespread changes to the regulation of the US financial system.

Apart from the section of the bill providing increased consumer financial protection, the bill provides for the orderly dissolution of failing firms, ending “too big to fail”, and tough restrictions are to be imposed on government assistance to banks in times of crisis, so as to eliminate bailouts.

It will create a new body to monitor the market to identify potential threats to the stability of the financial system.

Financial firms judged as posing a threat to financial stability will be subject to much stricter standards and regulation, including higher capital requirements, leverage limits, and limits on concentrations of risk.

The bill also fills a hole that allows hedge funds and their advisers to escape regulation.

Banks will be required to retain a portion of the risk they generate, in order to provide market discipline for underwriting decisions, and there will be, for the first time, a comprehensive system of regulation of the over-the-counter derivatives market.

Restrictions will be placed on the banks' ability to trade derivatives and to take risks by trading on their own account.

In addition, all larger financial institutions will be required to disclose remuneration arrangements that include any incentive based elements. Federal regulators would be authorised to ban inappropriate or imprudently risky compensation practices.

Youssef, who heads one of the largest Islamic banks in the region, said the relative immunity of Islamic banks from the global crisis supports his view that derivatives and speculations are risky and a cause of financial trouble.

“I can satisfactorily point out that Islamic banks have been less affected by the global crisis because they do not deal in derivatives and speculative practices…these banks are involved in real funding and banking practices.”

Citing estimates by the Bank for International Settlement, Youssef said the US derivative market exceeds $300 trillion, nearly 20 times the size of that country’s economy. Worldwide, the derivatives market is estimated at around $600 trillion.

“As we head into a new financial order, there should be unified auditing standards to facilitate decisions by investors, who still face difficulties because of the gap in such standards in companies worldwide,” he said.

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