Posts Tagged ‘banking’
For the record. Links to both the reports below. Enjoy.
Last week, the banking world was gripped by the findings of a probe into the financial crisis by a powerful US Senate committee and the interim report of Britain’s government-appointed Independent Commission on Banking, led by Sir John Vickers.
Here are the reports:
Vickers Independent Commission on Banking (UK)
Levin US Senate Report (US)
A debate ensues in UK and to some extent in France, on the issue whether the financial sector is an underpinning of the economy, or a destabilising factor to the economy.
The debate is quickly moving to new taxes on transactions, but its unclear to me why that would solve either side of the debate, rather than merely be passed on to customers.
… … a “swollen” financial sector paying excessive salaries has grown too big for society
Here is more on the Tory plan for banking outlined in the attached White Paper [57 pages]. Politics aside, lets take a look at the merits of this proposal and how it aligns with the problems I have perceived within banking and that are exacerbated over the last 2 years.
The core issues I have seen are these:
- banks have become high dividend paying conduits due to protective regulation and tight association with Central Banks
- the regulatory protection produced a ‘cannot fail’ mentality about banks’ and ..
- this in turn resulted in no perceived need for a strong capital base, which …
- gave us excessive leverage on all bank balance sheets, and that ….
- leaves banks unable to withstand any economic hiccups, requiring …
- government to in effect nationalise the large banks, in order to…
- protect the economies of G8 countries from failing
Result: We are moving to an era of zombie banks otherwise known as financial utilities, leaving the question of which banks will rise above that and promote genuine innovation and better quality financial services for consumers. There are basic flaws I see in the banking business model, and observing the banking crisis has simply added validity to those – more to come on that. Meantime one of those flaws is a lack of capital retention in banks.
Banking 101 looks at retaining money for a rainy day. Banks have no money for a rainy day. Everything earned is re-invested in growth (new leverage) or paid out in dividends. Its a brilliant model in a perfect market – enough said.
Now that we have that out of the way, lets go to the Tory paper.
In the foreward we are off to a good start with this tidbit:
The crisis has also revealed that large parts of the financial sector had a free option at taxpayers’ expense. Profits were privatised during the good times, but because we cannot allow the banking system to fail, losses were socialised when things went wrong.
… and the crux of their solution
We will give the Bank of England the power to regulate the pay structures, riskiness, complexity and size of financial institutions, and require those with structures that put financial stability at risk to hold large amounts of capital as an insurance policy to protect the taxpayer. We will abolish the Financial Services Authority, and will create instead a strong new Consumer Protection Agency.
But then some things have a reek of political motivation and untintended consequences in this statement ..
We will empower the Bank of England to use capital requirements to crack down on risky bonus structures. From the banks’ point of view this will effectively introduce a ‘tax’ on risky bonus structures that incentivise employees to seek short term profits at the expense of longer term stability.
It is really hard to see how that kind of regulation could be managed without government being owners of the bank and embedded in the governance structure. But there is real support for Basle initiatives such as ..
We will introduce a “backstop” leverage ratio limiting how much banks can lend for a given amount of capital.
This one is awesome!
We cannot continue with a system where banks make huge profits in the good times but benefit from an implicit taxpayer guarantee when things go wrong.
And the punchline …..
If we are to minimise the chances and scale of future crises we need a policy framework that has both the analytical capacity to bring together these different factors and the corresponding powers to act decisively when risks are identified. In contrast Britain’s existing tripartite framework is confused and fragmented, with responsibilities, powers and capabilities split awkwardly between competing institutions.
This figure surprised even me … I know we have become accustomed to the word trillion, but do we really know how much money is involved here … our money!
The crisis has resulted in taxpayer support for financial institutions on an unprecedented scale. According to the IMF’s latest Global Financial Stability Report, central banks in the US, UK and eurozone have provided $9 trillion of support to the financial sector.
According to the Bank of England “total losses in financial wealth toward the end of 2009 Q1 were equivalent to around 50 per cent of the world’s GDP”.
And bearing in mind that US banks are not in good shape this comment on British banks is sobering ..
The end result was that British banks became amongst the most indebted, most leveraged in the world, with tangible assets 39 times tangible equity compared to only 17 times even in US banks.
What went wrong in our banks was therefore a reflection of fundamental imbalances that were allowed to build up throughout our economy over a decade. As George Osborne said earlier this year, “Our banking system is not separate from our economy; it is a reflection of it. Our banks hold a mirror up to the worst excesses of our society. And the unsustainable debts in our banks are a reflection of unsustainable debts in our households, our companies and our Government.”
This sentence summarises the context of the White Paper, and needs to be memorised imho:
The end result was a banking sector that was undercapitalised, dependent on unsustainable funding strategies, low on liquid assets, poorly governed by weak boards and driven by dangerously short term incentives.
The fundamental conclusion of the White Paper is that the problem is systemic and not personally accountable to the FSA staff. It is systemic because it was not physically possible for the FSA (or any of the other regulators) to aggregate and act on the range of risks that were appearing.
The senior management of the FSA have been commendably open about the failures of the tripartite structure in their own review of what went wrong. The FSA’s own report on Northern Rock stated that “some of the fundamentals of work on assessing risks in firms (notably some of the core elements related to prudential supervision, such as liquidity) have been squeezed out”.12 The problem with the existing arrangements is not the people at the FSA, many of whom are very good, but the inherent problems created by the current structure. Despite their efforts to improve the FSA’s operations since the beginning of the crisis, the FSA’s management remain limited in what can be achieved as long as the flawed tripartite structure remains in place.
In summary, Gordon Brown made five crucial errors in macroeconomic policy and financial policy as Chancellor: creating the flawed tripartite structure; removing the Bank of England’s historic role of calling time on the levels of credit and debt in the economy; removing housing costs from the inflation target; running an increasingly unsustainable fiscal policy; and consistently ignoring warnings on the risks building up throughout the financial system.
Moving ahead to solutions, these principles are outlined ..
There is an emerging international consensus on many of the solutions that are required to prevent a crisiof this magnitude happening again. These include:
• Increasing the quality and quantity of bank capital
• Increasing capital requirements for risky trading activities
• Introducing limits on banks’ leverage
• Improving the regulatory focus on liquidity
• Regulating risky remuneration structures
There is an interesting discussion on the “Too Big to Fail” problem. RBS is singled out with liabilities of £2.06 trillion which places it at 142% of UK GDP. This cries out systemic risk (remember Iceland)
The White Paper solution:
We will abolish the FSA and the failed tripartite system and create a strong and powerful Bank of England with the authority and powers to protect financial stability.
- The Bank of England will be responsible for macro-prudential regulation, judging and controlling risks to the financial system as a whole. This will restore the Bank’s historic role in monitoring the overall level of credit and debt in the economy, and builds on existing Conservative proposals for a Debt Responsibility Mechanism.
- This macro-prudential role will be carried out by a new Financial Policy Committee within the Bank, working alongside the Monetary Policy Committee, which will monitor systemic risks, operate macro-prudential regulatory tools and execute the special resolution regime for failing banks.
- The Financial Policy Committee will include independent members in order to bring external expertise to bear on the problem of maintaining financial stability. It will include the Governor and the existing Deputy Governor for Financial Stability, who also sit on the Monetary Policy Committee, in order to ensure close coordination between monetary and financial policy.
- The Bank will also be responsible for the micro-prudential regulation of all banks, building societies and other significant institutions, including insurance companies.
- This micro-prudential role will be carried out by a new Financial Regulation Division of the Bank, headed by a new Deputy Governor for Financial Regulation, who will also be a member of the Financial Policy Committee.
- The work of the Financial Regulation Division will be overseen by the Financial Policy Committee to ensure close coordination between macro-prudential and micro-prudential regulation.
- We will create a strong new Consumer Protection Agency with responsibility for protecting consumers. This will create a new framework and culture for financial services consumer protection regulation.
- We will simplify the system by moving responsibility for consumer credit regulation from the Office of Fair Trading to the Consumer Protection Agency, reducing the number of overlapping regulators responsible for consumer protection.
The remaining pages go into much discussion on derivatives, other countrys’ approaches and consumer protection. Thinking of innovation, there is an interesting section on new banks …
While it is obviously imperative to ensure that any new banks are sound and run by fit and proper individuals, we should look at how it might be possible to streamline the approval process in order to encourage new entrants.
Relevance to Bankwatch:
All in all, this is a thoughtful paper, with only occasional lapses into politics, but generally one that focusses on problems and solutions. There will be a hue and cry that it deals with yesterdays problems and that future crises will be different. I would argue that notwithstanding future problem types, there are obvious problems with the banking business model that requires attention while we sort out the nature of new problems we have not yet encountered.
The issue of unintended consequences is something I worry about, but this paper genuinely aims at known issues of bank leverage, regulatory fragmentation, and inadequate consumer protection. This is not a bad framework to begin.
In this video commentary on the US Banks results they note that while large profits are announced, any parts of the business related to the US consumer consumer is flat. This includes all retail banking and credit cards. The only bright spots are the fee based revenue from the investment banking units, hence JP Morgan and Goldman Sachs results, although poor old Citi did not even make it there.
One quarter does not make or break anything in banking in and of itself. However the predictions of Roubini and Baker linked below are playing out as expected, so which banks are going to wait it out and hope for the best, and which will challenge and break out?
The problem with Citi it is not firing on any cylinders, at least with the others they are at least firing on one cylinder.
Relevance to Bankwatch:
The word ‘bank’ is quite generalised. On this blog I focus on retail and commercial (small ‘c) banking. I care little about investment banking. Looking at the US this week, the US consumer base is still being hit with ever increasing unemployment, and there is no indication that will change soon. Europe and Japan are no better. I go back to an earlier post about ‘recovery’ which is a word used too loosely by economists and politicians. What will the future look like? What will recovery look like and what does that mean for your bank?
While technical recovery meaning positive GDP growth may occur later this year or earlier next, that is of little interest here. That ‘recovery’ is driven by Government deficit spending in all major economies. What matters is the state of the consumer, their aggregate confidence level, and frankly their income level with which they choose to save, pay down debt or spend.
I will repeat that banks as they move into this post ‘recovery’ world will do well to consider what it will take to succeed in that world. James Baker worried about Zombie banks back in March. We are beginning to see the evolution of zombies, financial utilities who operate under government supervision and ownership with little benefit if any to people or the economy.
If it is not going to look like the pre recession world and if we accept that it will be a relatively smaller, more careful world with far less money velocity, then how should your bank adapt products, services, service and business model to thrive?
This paper reviews financial services over the past century, and concludes that banking wages are generally less as an industry during periods of increased regulation.
In recent research, Thomas Philippon of New York University’s Stern School of Business and Ariell Reshef of the University of Virginia conclude that the financial sector was a high-skill, high-wage industry between 1909 and 1933. It then went into relative decline until 1980, whereupon it again started to be a high-skill, high-wage sector.* They conclude that the prime cause was deregulation, which “unleashes creativity and innovation and increases demand for skilled workers”.