Regulators have been making a concerted push for banks to hold more equity as a protection against loss and overly-optimistic valuation of trading assets. But the head of the Bank of International Settlements, Jamie Caruna, argued at a secret (not) central bankers’ conference in Sydney that banks also need to carry more in the way of liquid assets (note that this recommendation apparently came in the form of a paper, but we can find no such document at this hour at the BIS website).
Caruna recommended that banks hold enough to allow them to survive a month without access to funding. Note that idea only seems radical now, since banks have spent decades perfecting the art of running lean. The rule of thumb in banking is to lend out $9 of every $10 in deposits. In the 1960s, only $5 of loans versus $10 in deposit was considered prudent.
From Bloomberg:
Capital and liquidity buffers need to be built up in good times so that they can be drawn down in bad times,” Caruana said. “Banks should hold a sufficient stock of high-quality liquid assets to be able to survive a month-long loss of access to funding markets.”
The Basel Committee proposed in December that banks should keep assets that are simple to value and wouldn’t have to be sold at fire-sale discounts during times of stress.
Lenders should also increase the amount of equity and retained earnings they hold to help them cope with losses better, the Basel Committee said last year. Banks’ core capital should exclude stock with preferential dividend rights to reduce risks to the financial system, it said in a report.
“Capital requirements are the speed limits of banking,” Caruana said today. “Capital requirements should draw on deep pockets that can absorb losses. An idea worth exploring is whether those pockets might be usefully deepened by debt that is convertible to equity when times are bad.”
Simple and slow banking is, of course, less profitable in good times than the kind we’ve had over the last two decades. But banks were kept comfortably profitable and low risk via strict regulation for nearly five decades without having a major crisis (from the 1930s through the sovereign lending mess of the late 1970s). Although the financiers will fight it tooth and nail, simple, stupid banking looks a lot better than what we have right now.
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Caruana is the former Governor of the Bank of Spain. Although his current job is not for Spain or the EU, one is tempted to think that his ideas for eunuch-banking have been discussed/vetted/tacitly endorsed, or whatever, by the European peers beforehand.
So we used to have i-banking, can we call its successor e-banking?
“high-quality liquid assets to be able to survive a month-long loss of access to funding markets”
I have difficulty in understanding what this means. How much would this be in practice? At what level of functioning for that month are we talking? Why one month? Where would the central banks be during this time? Sitting on their thumbs? Are demands on bank credit spread out through the year or would some months be worse than others? Maybe in the past, high-quality liquid assets would be taken to mean Treasuries or their international equivalents but nowadays I prefer statements like this to be explicit. In the absence of controls on gearing, derivatives, and other instruments and activities that magnify risk, would this make that much of a difference?
To me, this sounds like recycled Turbo Timmy talking about increasing reserve requirements on TBTF. It didn’t seem like much of a plan then either.
I did have a wee problem with the attempt to be specific, as opposed to the general concept. But this is a Bloomberg account of a paper, the formal rendition may be sensible than this snippet.
And I suspect, no matter how you try to measure it, that few/no banks meet this test now. So this is an effort to throw down a gauntlet, and he many have used the one month idea as what we call in consulting a “forcing device” (present an idea and let people shoot at it because you will get a better answer out of the debate you stir up). But having said, that, it would have been better to have someone less senior throw out a trial balloon of that sort.
This is the paper methinks:
http://www.bis.org/publ/bcbs165.pdf?noframes=1
Some bore wrote a great screed about it on this very site.
http://www.nakedcapitalism.com/2009/12/basel-iii-%E2%80%93-the-ok-the-unfinished-and-the-ugly.html
The bore doesn’t go into the liquidity side much but does have this to say:
The intention here is not so much to prevent fiascos like Northern Rock or HBOS, (both of which would have been lossmaking, rather than hopelessly illiquid, if they had had sane funding models), but rather, to enable the authorities to get warning of an approaching liquidity problem, or at the very least, to give them a known timeframe in which to sort out the problem once it’s hit. So there are three prongs: first, a 30-day liquidity coverage ratio requirement, so that the authorities have that long to sort out new capital from somewhere, even in the face of a bit of a run. Despite the BoE’s legendary slow response to Northern Rock, 30 days really ought to be long enough to sort out new capital for an institution of that size. For the likes of JPM or Citi, probably still enough, though there might be pressure from a more severe run than the base scenario in the document. Second, there is a longer-term structural liquidity ratio to which banks must adhere; common sense, really. Third is a common set of monitoring metrics to assist supervisors in identifying and analysing liquidity risk trends at both the bank and system wide level; also common sense.
I would add that the specification of what counts as liquid looks…not too bad, certainly detailed, though who know what ways there will be of gaming it if it gets implemented.
Note Mr G. Yellow’s handy extra detail on what ‘a bit of a run’ is, further down the comment chain.
I have a slight feeling that the ‘run’ scenario might be on the tame side for the extreme events that we witnessed in late ’08. One needs more blow-by-blow detail about, say, the run on Morgan Stanley, or that buck-breaking money market fund, or what went on at Citi Q4 ’08.
Volcker Plan = “forcing device” ?
That was my argument. ‘Nuff said
Vanilla Greed cop Pernicious Greed cop theater meant to settle down the marks. Right on with the recycled Turbo Timmy, its the same game.
The thirty day amount is a signal to slow down the speed of exploitation and take down of the middle classes. ‘We are getting some resistance and we don’t want to lose control.’ The, “debt that is convertible to equity when times are bad.” line says focus on grabbing the most valuable natural resources as opposed to any humanitarian funding bullshit.
Deception is the strongest political force on the planet.
“It could be woice,” said the hammer to the nail.
:)
“It could be bettah.” said the board, “And its knot fair leaving me out.”
Not only is simple, stupid banking to be recommended, but we do well to remember that ‘today’s invention is tomorrow’s mess’ and that, as they say in Zen that Zen is nothing more than ‘carrying water and chopping wood,’ we must have the audacity to be ordinary, for ordinariness brings beauty, harmony, peace and tranquility, and in fact, you find the true Zen master in the noisy marketplace, maybe he’s just an ordinary butcher or vegetable vendor, rather than someone at the mountaintop (probably couldn’t meditate with all the noisy distractions when a true master should be able to and could) who attracts hippie musicians or goes around the world winning Nobel prizes.
Remember, before you enter the Way, a mountain is just a mountain, and when you start to practice the Way, you realize a mountain is more than a mountain, but after after you have known the Way, a mountain is again just a mountain. It’s all very simple and ordinary…like banking
OK, that was funny.
Note that idea only seems radical now
That’s generally applicable to everything we need to do.
The main enemies are inertia and the Status Quo Lie.
Note that idea only seems radical now
That’s generally applicable to everything we need to do.
Our main enemies are inertia and the Status Quo Lie.
Sorry for the duplicate – it didn’t show the first time.
Here’s an irrelevant movie quote the headline made me think of:
“The Corleone family had lots of buffers.”
Well, not quite irrelevant. Whenever I come to one of these sites I always have gangsters on the brain.
“Mark to market model make believe mammon mantra” finance seems to be the biggest status quo lie of them all.
But you can’t get a mathematician to cease believe in something that his motorcycle depends upon being gasoline.
And so they all go to meetings and have meetings about their meetings, and then meetings about the meetings they had about their meetings — until it’s bonus time again.
The Reserve Bank of Australia website seems to have the speech.
http://www.rba.gov.au/publications/confs/2010/caruana.pdf
The paper is here. It was published in December.
“How much would this be in practice?”
Depends on the institutions projected net outflows.
“At what level of functioning for that month are we talking? ”
The scenario entails:
• a significant downgrade of the institution’s public credit rating;
• a partial loss of deposits;
• a loss of unsecured wholesale funding;
• a significant increase in secured funding haircuts; and
• increases in derivative collateral calls and substantial calls on contractual and noncontractual off-balance sheet exposures, including committed credit and liquidity facilities.
“Maybe in the past, high-quality liquid assets would be taken to mean Treasuries or their international equivalents but nowadays I prefer statements like this to be explicit.”
It is. The paper defines criteria for the high quality liquid assets buffer and lists several categories that are definitely eligible: cash, reserves, 0% risk weighted sovereign and supranational bonds, domestic currency government bonds. It also says the BIS will consider allowing certain other categories such as covered bonds, pending further analysis and subject to haircuts and other restrictions.
Lending five against deposits of ten is a very good rule. Now lending five against deposits of ten with retained earnings of five could eliminate the need for deposit insurance. The goal here is always solvent banks.
As you increase the level of accepted risk your investment becomes increasingly speculative. If you hold yourself out to be a bank, you are making a representation of soundness. As you lever-up you are becoming increasingly unsound. That’s tantamount to a fraud.
Markets will not of themselves prosecute fraud. Capitalism left to its own will destroy unsound practices and fraud. There is a problem with that. It takes time and when the correction comes, the evil doers are often gone and the dupes are left holding the empty bag.
All of the blogoshere is becoming a dilitante’s debate. It’s Macbeth in spades: come, let me clutch thee thou little CDO. Let me take thee to my hand and squeeze thee. Lo, you are not even a turnip, I need a CDS who will sell me a turnip. Verily, I will sell my soul for a pittance. What’s a pittance, it’s a dollar circa; 1914 it bot a dollar’s worth of stuff. Today, in 1914 measure, it buys a nickle’s worth of stuff.
As to reform, I expect nothing less than tooth and tong from the financial finessers; but then, it is they rather than the lawyers who we must first slay!
Ignore the details here. The guy from the BIS is saying that the banking system is grossly undercapitalized. We knew that all along; but then did we know it? It seems not so we are relearning the lessons of history. See Reinhardt and Rogoff.
Apologies to Will etal.
You need to watch your comments now boys and girls if you are posting from the very chilling fascist state of South Carolina …
Excerpt;
Subversives who think government is corrupt and should be controlled by the people face 10 years in prison and a $25,000 dollar fine if they fail to register with authorities in South Carolina, in another chilling example of how free speech and dissent is being criminalized in America.
The state’s “Subversive Activities Registration Act” is now officially on the books and mandates that “Every member of a subversive organization, or an organization subject to foreign control, every foreign agent and every person who advocates, teaches, advises or practices the duty, necessity or propriety of controlling, conducting, seizing or overthrowing the government of the United States … shall register with the Secretary of State.”
Of course, the right to overthrow a government that has become corrupt, abusive and completely unrepresentative of its electorate is enshrined in the Declaration of Independence – that’s how America came to be a Republic in the first place – advocating or teaching that the people should “control” the government via their elected representatives is a basic function of a democratic society, but this law effectively makes it a terrorist offense.
“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness,” states the Declaration of Independence.
Under the sweeping terms of the law, members of tax protest organizations, the Tea Party movement and the States’ Rights movement based in South Carolina are all domestic terrorists if they fail to register their dissent with the authorities.
It is important to stress that the notion this law somehow only applies to “Islamic terrorists” is completely at odds with the fact that federal and state authorities now consider the main terror threat to be from informed American citizens exercising their constitutional rights in opposition to the big government agenda they are being subjected to.
As we saw with the MIAC report and a plethora of similar training manuals which were leaked over the last decade, police are being trained that libertarians, gun owners, Ron Paul supporters and anyone who is mildly political is a domestic extremist and a potential terrorist – these people are the real target of the subversives list in South Carolina.”
More here …
http://www.globalresearch.ca/index.php?context=va&aid=17513
How does NC feel about this?
Deception is the strongest political force on the planet.
“In the 1960s, only $5 of loans versus $10 in deposit was considered prudent.”
Well in Biblical times interest was illegal. Equally irrelevant.
In theory, capital reserves would, and could be determined entirely by the banks themselves. Yes, and banks with high risk profiles would have higher cost of capital because of their need to pay it to attract deposits.
Thusly, safer banks, (50% 100% 1000% – doesn’t matter) would attract money cheaply, but earn less. Its called the free market.
Until you strip the notion (enforced by FDIC and FED) that all banks are created equal, the natural process of risk assessment by the customer can never begin.
The only regulations you would need is transparency for customers, so people knew the risk profiles of various banks. This would unleash an enormous NEW regulatory agency known as the American Public on these banks.
Banks are subsidized and protected. Unleash the customer on them. I mean we are already paying to insure our own deposits, so what does FDIC actually protect? Strip away the illusion of protection please. Sound scary? you could still buy insurance for deposits – that need could easily be met, and cheaper i suspect, by private insurers who would assess the risk profile of your bank.
great post scharfy. the process of dismantling state-subsidized banks will require a complete overturn of history and social programming vis-a-vis ecopolitical agendas. I am going to save your post for future reference. an independent political movement based on sustainable eco-logical strategies with no social agenda other than universal education and the eradication of poverty and learned helplessness.
Since BIS has been brought into the mix its time to consider its role in the overall debate.
The Global regulatory framework for banks rests on three basic concepts
The Three Pillars
1.Minimum Capital Requirements
2.Supervisory Review Process
3.Market Discipline
Dismantling the framework is anathema to the banks that have successfully gamed it and to the global regulatory agents, especially the FED, responsible for implementing regulatory improvements which fit within the framework. Indeed, the WTO rules effectively force the US to comply with the framework
Any analysis of reform proposals that doesn’t consider the impact of or on the global framework falls short.
For example the SIVs and the shadow banking system escaped the controls in the existing regulatory framework by exploiting accounting rules that enabled their sponsors to technically separate themselves from their sponsors . The FDIC securitization proposals recognize and address that issue here in the US. If the accounting policy loophole (exploited globally) didn’t exist the SIVS would not have existed, the CDO market might have been contained and perhaps we would have avoided the entire crisis. The fault lies with FASB/IASB and the deference paid to them by reglators and governments. A discussion of their role, like the ratings agencies, needs to be included in the mix.
If Bear, Lehman, (and MS&GS) were brought down by of the CDO/CDS market fueled by the shadow banks, then the enabler of the shadow bank system should be a major focus.
In the case of the IBanks in the US, although in theory they would be required to hold capital consistent with global capital requirements for the banks, they received waivers that give them a regulatory advantage over their banking peers. Now that they are technically banks, or rather financial holding companies in GS case, banking capital requirements should constrain their activites, except that they are still operating with those waivers.
In the case of AIG, mark to market and reporting transparency requirements would have alerted everyone earlier and alternatives to a bailout might have been developed if they didn’t have the benefit of secrecy. Again this is a FASB/SEC failure. Everyone was, and still is gaming those rules. (I’m not saying AIG was FASBs fault, I’m just pointing out that transparency is critically important and the regulatory proposals give little attention to its significance)
I’d argue that the components of the framework need improvement, but the framework itself, if it covers the shadow banks and the US IBanks, survives and might have mitigated the abuses we’re suffering from now. At a mimium the shadow banking activity would have been more costly to SIVs. There are still enormous flaws in the components, notably the risk weighted capital rules which incent the banks to hold AAA securities, which had the perverse effect of fueling the shadow banking system
The debate needs to expand to include the significance of the global regulatory framework if the proposed remedies are to be adequately vetted.
As a result of the gathering up of the key US financial institutions under the Feds tent, there’s a reasonable chance these institutions will be regulated consistent with the global framework. This is a step forward.
Hopefully, this won’t be read as a simplified analysis, but instead as a summary of an overarching theme (like it or gloval banks are regulated globally to a great extent) that should be considered as we evaluate reform proposals.
The thirty day requirement is to allow regulators time to think during a crisis. Recall that the US regulators were operating on no sleep between mid august and the election, issues came at them so fast. If Lehman had been able to handle a month before bankruptcy was required, rather than 3 or 4 days, more thought could have been given to what to do better due diligence and the like. It makes a lot of sense. Essentially kill the overnight repo market, and require loans at a minimum to be 30 to 60 day ones.
Not so sure this would have helped Lehman. Maybe they had dodgy accounting or something, but supposedly they had the strongest liquidity pool of all the broker-dealers.
For eg, from Bloomberg,
Lehman’s so-called liquidity pool — consisting of cash, money market instruments, corporate bonds and stocks that can be sold quickly — is the strongest among the five largest brokers, according to Sanford C. Bernstein & Co.
`Navigate Through’
Lehman’s $98 billion liquidity pool compares with $61 billion at Goldman Sachs Group Inc., the largest and most profitable securities firm, according to Bernstein analyst Brad Hintz. Bear Stearns had $17 billion at the end of the fourth quarter.
Lehman’s liquid assets are more than five times greater than its shareholders’ equity. At Merrill Lynch & Co., the world’s largest broker, and Morgan Stanley, the second-biggest U.S. securities firm, the ratio is three times equity. Goldman’s liquid assets are double its equity.
“Over the last 20 years, the U.S. securities industry has learned through experience how to navigate through financially stressful events that can damage confidence,” Hintz, a former Lehman finance chief, said in a report today.
According to Lehman’s annual report, the firm had $35 billion of cash at the end of November and an additional $159 billion of “unencumbered assets” that aren’t financed by borrowing or tied to other financial commitments.