David Prosser: Dubai crisis could have been far worse

Outlook While the Dubai crisis rumbles on, the consensus on international markets is that this is turning out to be a little local difficulty rather than a new phase of the global credit crunch. That may be so, but how much worse might the contagion have been without new rules, introduced earlier this year, on mark-to-market accounting of banks' assets?

Within minutes of Dubai World announcing its debt standstill a week ago, the spreads on derivatives such as credit default swaps, which measure the risk of insuring against a default, widened dramatically. Under the rigid system that applied prior to the credit crisis, any bank holding such assets would have had to write down their value accordingly.

Since we are coming up to the year-end, those mark-to-market rules would then have seen many international banks forced to record heavy losses, in addition to the losses they may or may not incur on lending to Dubai. And that might have caused a new run on confidence in banking systems.

Fortunately for the banks – and, in some ways, the rest of us – accounting and securities regulators have made some concessions on the mark-to-market regime, recognising that some discretion needs to be applied during periods when the market for a particular asset is disorderly.

Those who claim mark-to-market rules were a cause of the financial crisis are wide of the mark – had banks not over-exposed themselves to risky assets in the first place, the rules would never have caught them out. And allowing too much discretion on asset valuation has its own risks. Still, the Dubai affair underlines the case for applying accounting standards sensibly – there's no point in having rules that have the potential to turn molehills into mountains.