Are the banks ready for Y2K?

At last the fears and nerves surrounding the millennium date change are reaching a climax. After years of preparations and uncertainty, the changeover date is imminent and the answers to the Year 2000 challenge will become abundantly clear.

Will there be a catastrophe that will paralyse economies worldwide and cause untold chaos and damage? Or will the inability of many electronic systems to recognise unambiguously "00" when 1999 changes to 2000 be a potential problem similar to the story of the "dog that did not bark"?

Unfortunately, before the change takes place, there are no definitive answers and no-one really knows what will happen when the new millennium begins. No-one can be sure that the billions of money spent on testing and Y2K compliance will prove effective. But, having given this disclaimer, there is evidence available that should give a certain level of comfort that disasters can be avoided.

Nevertheless, the remarkable aspect of the Y2K issue is that, despite the years of advance warning and enormous resources applied, the amount of hard data in the public arena on the extent of compliance and contingencies is surprisingly scant. While the technical complexity in testing millions of pieces of computer code to eliminate the so-called "bug" is no doubt great, actual results are difficult to assess, particularly from the outside.

In the past two years, THE BANKER has conducted two extensive Y2K surveys of the world's Top 1000 banks. The results, published in April 1998 and April 1999, provided ground-breaking information in a business sector considered to be better prepared than most. But such data, as good as it was covering almost half the world's top banks, was hardly an audit of their computer systems and was thin on verifiable content. How reliable the Y2K questionnaires and the like prove to be in assessing systems in all industries, including the financial sector, is a question regulators and governments will be able to answer only in the New Year.

With very little specific public information available, people around the world rely on the statements of officials and governments to clarify the situation. But, given that many officials are obliged to avoid creating panic and unnecessary chaos, it is not entirely clear for a variety of reasons how reliable the available data is. Are the various prognostications wishful thinking or is there objective evidence to back up stated positions?

Even if data was better and more widely available, how are the risks of contagion between various sectors in the economy to be evaluated? The UK's Taskforce 2000, for example, in early November advised in one of its bulletins: "People should, if possible, avoid international travel during a period of five weeks from just before Christmas 1999 to the end of January 2000." The Taskforce also named countries that qualify for its air travel "red light" (serious risk of disruption) and these include Germany, Italy, Spain and Switzerland. The Taskforce says its listing is derived exclusively from the US Department of Transport website and is not intended to be exhaustive.

What should be believed? Concrete evidence is lacking, and effectively gauging the level of risk in such an idiosyncratic event is both unprecedented and unconvincing. Nevertheless, some comments may prove useful. Alan Greenspan, chairman of the board of governors of the US Federal Reserve Board, recently provided some optimism. He proclaimed: "While systems may fail as they have in the past, these failures never have resulted in broader and persistent - that is, systemic - breakdowns in our economy.

Notwithstanding, it is at least conceivable that, as a consequence of our current dependence on computers, some Y2K-related failures could have noticeable effects on the economy. But as a result of vast effort and an estimated $50bn of expense by the private sector, enough of our critical infrastructure has been judged Y2K-compliant to view the probability of any systemic breakdown as negligible, even granting the uncertainties associated with our interconnections with less-prepared foreign countries."

Although acknowledging the complexity of the problem and that something is likely to slip through the cracks Mr Greenspan summarised the US position as: "The probability of a cascading of computer failures in mission-critical systems is now negligible, given the testing that has been done, the back-up plans that are in place, and the great adaptability and ingenuity of the American worker." So if Mr Greenspan is to be believed and the US is safe, what about the rest of the world? The OECD recently expressed its concerns about the impact of Y2K on financial markets.

It said: "While the end of any normal calendar year is generally accompanied by funding pressures in money markets owing to higher demand for cash on the part of the public, reduced willingness to lend on the part of intermediaries and, more generally, 'window-dressing' operations for balance sheet reasons, greater awareness of the potential for computer-related problems on the changeover to year 2000 seem to have exacerbated such effects. "Market participants' fear of disruptions to liquidity have triggered, on the one hand, a reluctance to operate on the date and, on the other, hedging or speculative operations in forward markets that have increased implied funding costs."

The OECD added: "As regards the valuation of securities of longer duration, market expectations seem to focus on three possible risk factors: (1) the millennium bug could trigger macroeconomic instability; (2) the functioning of some market places could be impaired; and (3) investors' preference for liquidity at year-end could temporarily depress the valuation of financial assets. The first two of these risks appear to have induced markets to put a discount on the assets of countries and institutions perceived as less well prepared to deal with the Y2K problems. As for the third, there is mounting evidence of securities issuers planning their issues schedules with a view to avoiding the end of 1999."

As for focusing on specific banks and banking sectors the regulators and rating agencies such as Moody's have provided some core information and perspectives that can be seen in the following pages. But again fear of "shooting from the hip" and concerns by rating agencies of taking precipitate actions on perceived Y2K problems have led to some heavily qualified comments.

Yet, despite the reluctance of the major players to speak in other than guarded terms, some comments on Y2K preparedness are useful. Moody's takes the following regional views: l Banking systems in the UK, Ireland, the Nordic region, Belgium, Luxembourg and the Netherlands appear to be ahead, having conducted system-wide tests and with contingency plans better advanced; l Banking systems that appear to have started relatively later are in Austria, France, Germany, Portugal, Spain and Italy.

Nevertheless, Moody's has not identified any significant concerns at this stage that would lead it to contemplate rating actions. There is, nevertheless, a relatively higher degree of Y2K-vulnerability for some of these banks; l Banking systems in Chile, Brazil, Mexico and Colombia appear to be as far ahead as the more developed markets, having conducted several system-wide tests and with contingency plans well advanced or already in place; l Banking systems that appear to be somewhat behind these more advanced systems in Latin America are Argentina, Peru and Venezuela.

Moody's concludes that the large banks in the developed markets seem to have made the necessary preparations and appear to be ready for Y2K with little chance of systemic risk. In developing markets, the risks, not surprisingly, are seen as higher, but having said that, many such countries have to cope daily with delays and massive interruptions so Y2K problems may not necessarily provide the shock that they could in more sophisticated markets.

Overall, the event is likely to prove to be the dog that did not bite but, given the complexity and the lack of reliable data, the best advice is "don't bet on it".