Modest bank profitability - down from before the financial crisis - and potential over-harsh capital rules are challenges to be met, the Monetary Authority of Singapore's chief has said.

There is a risk that overly harsh capital requirements on the world’s banks and wafer-thin interest rates, as seen in recent years, will hamper institutions’ profits and impede economic growth, the head of the Monetary Policy of Singapore has said.

While the banking system is in some ways more resilient against adverse market and economic events than before the global financial crisis, there remain shortcomings, Ravi Menon, managing director of the MAS, told a recent conference.

Menon said there has been “good progress” in beefing up capital requirements on banks, improving liquidity and funding, and tackling the “too-big-to-fail” problem of banks as revealed by the crisis.

But he added a word of caution: “While the effect of regulatory reforms on the broader economy has so far been benign, regulators must continue to pay close attention to the cumulative effects of various reforms and seek to minimise adverse consequences for the real economy.”

The UK vote to leave the European Union, concerns about the deceleration of the Chinese economy, debt strains on Italian banks and economic woes in countries such as Brazil have roiled markets in recent months. In the US, there remain concerns that the country continues to store up unsustainable levels of debt and that its banking system is still concentrated among too few players. 

Menon warned about the state of profitability in the banking sector, and the distribution of credit to parts of the economy.

“Regulators are not in the business of ensuring profits for banks. But we have an interest in the profitability of banks for two reasons. First, banks need to be profitable in order to be strong. Second, banks need to be profitable in order to be able to support the real economy,” he said. 

Since the crisis erupted, Menon said, “bank profitability has come under pressure in a prolonged period of low growth and low interest rates” and return on equity has fallen sharply. He said the average ROE of the 200 largest banks in the world has slumped from 17 per cent in 2005-2007 to 9 per cent in 2011-2013.

“Monetary policy, as it comes up against diminishing returns at the zero lower bound, is also not helping bank profitability. As policy rates are pushed into negative territory in a growing number of countries, the implications for financial stability need to be assessed carefully. In a low or negative interest rate environment, banks are likely to engage in market segmentation and charge different rates to different groups of clients,” he said.

Menon also warned that “there is a real risk that overall capital requirements on banks could indeed increase significantly if we are not careful”; he highlighted the dangers of adopting very conservative risk weights by banks.

“We have already achieved more or less the right level of capitalisation for the banking industry through the initial set of Basel III reforms after the financial crisis. If we now precipitate a further increase in the level of capital requirements in the process of adjusting the framework and fine-tuning the calibrations, it would unduly constrain credit intermediation and consequently economic growth,” he said.