Archive for the ‘regulation’ Category
There has been much talk of systemic risk since the financial crisis hit. I see it more as a crisis of banking and banking confidence, and the debate on systemic risk is critical because it exists because of Government intervention and protections, implicit and explicit. The latest from Lord Turner of the FSA is a discussion paper, that reviews systemic risk and provides as good a discussion on that topic as I have seen.
What it particularly interesting is how the insights raise the prospect of penalising globally integrated banks over nationally independent organizations with higher capital requirements. Things just got more complex for decisions on integration.
3.18 In general terms, a firm is systemic when its collapse would impair the provision of credit and financial services to the market with significant negative consequences for the real economy. The factors which make firms systemically important fall into three categories (although firms may combine elements of these factors):
- systemic by size. This can be a function of the firm’s absolute size or in relation to a specific financial market or product in which a firm is particularly dominant. The channels through which systemic risks would crystallise as a result of the failure of such a firm include: losses to uninsured creditors and depositors through high bankruptcy costs and reduced recoveries; disruption to financial services (such as to payments, clearing and settlement, extension of credit); and losses to insured depositors because the DGS could not pay out sufficiently quickly or because the aggregate payout imposes unsustainable costs on those who fund the DGS. In addition and crucially, systemic risks can take a macroeconomic form, with the loss of credit extension capacity leading to, or exacerbating, a downturn in economic activity which then has consequences for the rest of the financial system.
- systemic by inter-connectedness. Links and inter-connections can include, inter alia, inter-bank lending, cross holdings of bank capital instruments, membership of payment systems, and being a significant counterparty in a crucial market. The channels through which such problems manifest themselves include:
- interbank exposures. The domino effect where the collapse of one firm leads to
major losses at others, and then in turn leads to their collapse. This can then
trigger a chain reaction;
- the confidence channel. The collapse of a systemically important firm leads to a
crisis of confidence in financial markets. The confidence channel is particularly
important to the ‘systemic as a herd’ category (see below), given the perceptions
by the market that a number of firms are exposed to the same set of risks;
- the asset margin spiral channel. Firms increasingly finance themselves through repo
and reverse repo arrangements. The haircuts charged on the collateral underlying
these contracts dictate the extent to which firms can leverage themselves. In a crisis,
both funding conditions and credit concerns will lead counterparties to increase
haircuts, triggering a deleveraging process. This will in turn be disruptive, through a
self-reinforcing spiral between lower market liquidity and funding liquidity.
- systemic as a herd. The market can perceive a group of firms as part of a common group (for example, because they have a similar business model, such as building societies in the UK and the savings and loans banks in the US), or common exposures to the same sector or type of instrument. A single firm in this group may not be systemic in its own right, but the group as a whole may be.
The US administration released a draft of their proposed regulatory framework today, putting the Federal Reserve front and centre.
The big theme is to promote broader control of any institution involved in banking, and to specifically eliminate exemptions such as the Thrift Charter.
Draft Fed report on Financial Institution Regulation pdf – 85 pages
The IMF report had a spreadsheet in the appendix with bank capital levels around the world.
While it has individual countries, I summarised into this chart. The data shows Capital as a percentage of Assets so higher is good, lower is bad.
Note the negative trends in most except Canada, and this is based on the latest data to end of 2008. Use the thumbnail for a larger version that is clearer.
I saw somewhere earlier that the President was planning a major economic speech tomorrow, and now this below is finally coming after being delayed while some banks announced. This probably explains the context.
WASHINGTON — The Obama administration is drawing up plans to disclose the conditions of the 19 biggest banks in the country, according to senior administration officials, as it tries to restore confidence in the financial system without unnerving investors.
Lionel Barber at the FT interviews US President Obama in advance of the G20 meeting Thursday. Despite the broad sweeping answers it seems unlikely that we will see much tangible outcome from the session, but the G20 draft communiqué (below) is clear about stronger regulation.
Obama interview: Full text | Financial Times
FT: Let’s talk about the G-20. What will be your benchmarks for success?
Obama: The most important task for all of us is to deliver a strong message of unity in the face of crisis. There’s some constituent parts to that. Number one, all the participating countries recognise that in the face a severe global contraction we have to each take steps to promote economic growth and trade; that means a robust approach to stimulus, fighting off protectionism.
Next, we have to make sure that we are all taking serious steps to deal with the problems in the banking sector and the financial markets and that means having a series of steps to deal with toxic assets and to ensure adequate capital in the banking sector.
Third, a regulatory reform agenda that prevents these kinds of systemic risks from occurring again and that requires each country to take initiative but it also requires coordination across borders because we have a global, we have global capital markets, and that will include a wide range of steps, additional monitoring authority coordination of supervisors and various countries dealing with offshore tax havens.
The G20 draft communiqué has been leaked to the FT and some directional clues are there. While the debate on stimulus and protectionism are less clear there seems little doubt we will see more regulation and regulation that is sweeping in nature across countries, Banks and economies … some snippets here, but worth reading if interested to get full context in the 2 or 3 pages.
Reforming financial systems for the future
14. We recognise that weaknesses in the financial sector and in financial regulation and supervision were fundamental causes of the crisis. …
• to work closely and systematically, in accordance with the Financial Stability Forum framework, to supervise cross-border institutions and to complete the establishment of colleges of supervisors for all significant cross-border financial firms;
• to improve over time the quality, quantity, and international consistency of capital in the banking system. Capital requirements should not be strengthened until a significant and sustained economic recovery is assured and the transition managed to ensure that the extension of credit is not constrained. Regulation should limit leverage and require buffers of resources to be built up in good times which banks can draw down when conditions deteriorate;
• each of us commits to candid, even-handed, and independent IMF surveillance of our economies and financial sectors, of the impact of our policies on others, and of risks facing the global economy;
Here is the Turner Review commissioned by the Chancellor of the Exchequer. Martin Wolf reviews here at the Financial Times. Wolf argues it is a watershed for finance making this excellent point –
“The most important analytical points are that individual rationality does not ensure collective rationality, that individual behaviour is frequently less than rational and that, in consequence, markets can overshoot, in both directions. Above all, such failings create systemic risks: if everybody believes in the same (faulty) risk models, the system will become far more dangerous than any individual player appreciates; and if everybody relies on their ability to get out of the door before anybody else, many will die in the inferno.
Here is the introduction in the report.
Over the last 18 months, and with increasing intensity over the last six, the world’s financial system has gone through its greatest crisis for a least a century, indeed arguably the greatest crisis in the history of finance capitalism. Specific national banking crises in the past have been more severe – for instance, the collapse of the US banking system between 1929 and 1933. But what is unique about this crisis is that severe financial problems have emerged simultaneously in many different countries, and that its economic impact is being felt throughout the world as a result of the increased interconnectedness of the global economy.
More analysis later. Here is the full report site, and link to pdf.
Following the banking crisis, the Chancellor of the Exchequer asked Lord Turner, in his capacity as our Chairman, to review and make recommendations for reforming UK and international approaches to the way banks are regulated.
Here, we publish Lord Turner’s Review and the supporting FSA Discussion Paper. These take an in-depth look at the causes of the financial crisis and recommend steps that the international community needs to take to enhance regulatory standards, supervisory approaches and international cooperation and coordination.
The Turner Review : [ PDF ]
A regulatory response to the global banking crisis
In the series “The Great Unwinding” last week two types of banks, Financial Utilities and Risk Takers were highlighted to appear. This direction received strong support this weekend with Alistair Darlings order to perform a complete review of bank practices.
The review is the not so thin edge of a large wedge when the ramifications are considered.
The chancellor said on Sunday that the review would look at risk management by boards including how pay affects risk taking; it would also look at the way boards operate and the role of institutional investors.
Mr Osborne (Shadow Chancellor) added: “The party is over for the banks. You can’t go on paying yourselves 20 times what a heart surgeon earns.”
Last October I wrote that RBS and Lloyds/ HBOS were effectively nationalised by the actions taken by the Government and since copied in other jurisdictions, mainly US. You will recall that the original intent promoted by TARP in US was to carve off the toxic loans into a “bad loan bank” which would have had the role of managing those loans. That approach would have allowed banks to continue to operate as smaller banks, with adequate capital. Additional controls on operations of banks to ensure stabiity of the system could have been implemented through appropriate regulation. Credibiilty and confidence in the banking system would have been restored quicker because the doubts about asset quality would be removed and presumably the remaining assets (bank loans) would have been operating normally and since there would have been less assets (investment) the capital base would have been relatively stronger.
However the British Government went straight to their socialist roots and went down the ownership route taking significant stakes. This is akin to taking a tiger by the tail – once you start you cannot stop as they are now finding. The rapidity which the US followed suit surprised me as they took stakes in the banks too. And just last week Obama found himself regulating bank executive pay limiting it to $500K. Neither government should be surprised by this. Of course their is popular outrage at bank executive pay and bonuses, and of course that outrage is directed at … the owners! The owners are the government who are politicians first, so now we have the politicians running around managing messages such as bankers bonuses. Once government starts with a review of internal governance and practices it is impossible to retreat from that slippery slope. Each item in the review will drive out sets of others that once viewed in the public eye will bring out additional political issues that will require additional political influence, and the snowball will grow and grow.
I am not agreeing or disagreeing with bankers bonuses. I am suggesting that that debate is irrelevant and distracting when it comes to solving the crisis of confidence in the banking system that is created by assets that are not accurately valued – in fact the doubts are such that a value of zero is the only rational value and this is displayed in the stock prices of those banks.
In fact nationalisation may be an appropriate approach even though I would not pick it. However the half in/ half out situation that the banks are in now is doing irreparable harm to those banks and to the economy both through failure to address the central issue of asset valuation, and through ensuring politically oriented non-management by those half in banks. Those same banks are destined to the category of Financial Utilities.
One a separate note, it probably is too late to create the bad bank now – and as Niall Ferguson recently wrote, that bank already exists. [emphasis mine]
Now the talk is of a new “bad bank” to buy the toxic assets that the Troubled Asset Relief Program couldn’t cure. No one seems to have noticed that there already is a “bad bank.” It is called the Federal Reserve System, and its balance sheet has grown from just over $900 billion to more than $2 trillion since this crisis began, partly as a result of purchases of undisclosed assets from banks.