Big banks are simply too big

Also investors may think so. As FT banking commentator Patrcik Jenkins notes in this post, banks are trading at very low book/values and investors may actually benefit from breaking up large conglomorate banks:

Shareholders appear to be coming to the view that banking conglomerates do not make economic sense. There are many factors subduing banks’ stock market values, including the eurozone crisis and global regulatory uncertainty. But another brake is investors’ fading faith in size for its own sake. Most western banks – especially the universal ones comprising retail and investment banking under one roof – are trading at a discount to the book value of their net assets.

This is a view that Andrew Haldane of the Bank of England also has voiced earlier, indicating that proposals for splitting trading and commerical banking actually may be in the banks best interest. A clean split – ala the Volcker rule – would then be preferable to a holding company solution as proposed by the UK Vickers commission. Time will tell which will be the choosen one.

IMF: Financial stability reform lagging behind

This VOX post by one of the leading authors of this years Global Financial Stability Report  Not making the grade: Report card on global financial reform | vox. argues that the pace of reform and restructuring of the financial sector is too slow. Important issues remain unresolved, including

• Financial systems are still overly complex.
• Banking assets are highly concentrated (Figure 3), with strong domestic interlinkages.
• The too-important-to-fail issues are unresolved.
• Banking systems are still over-reliant on wholesale funding (Figure 4)

There is still little progress (or politicla will?) to tackle the TBTF problem, and the financial system remain too complex. Shadow banking continue to be a problem, as well.

Key question is whether “traditional” program of reform, inkl. Basel 3, will deliver the required reforms in time? The lobbying pressure is intense, ref. the latest defeat of the SEC on money market reform. May be we need other approaches, ref. Haldane’s critique of Basel 3?

The neglected part of international financial reform: Liquidity regulation | vox

This Vox post by Stefan Schmitz from the central bank of Austria, is quite interesting. He describes the current back-peddaling on the liquidity regulation by key policy makers and argue strongly that the regulation should be implemented as planned.

If this collides with a shortage of safe assets, banks should reduce their short-term net cash outflows (p. 6)

This mismatch between the need for safe assets and the growing size of the financial (trading) sector is something I dealt with in my Levy WP 712: Shadow banking and the limits of central bank liquidity support.

It will indeed be interesting to see how the this regulatory fight will be influenced by the ongoing crisis.

Central bankers should admit their mistakes

Intersting summer interview with top brass Andy Haldane in Bank of England. He reflect on the state of economics and the need for financial reform.

He makes the case for fundamental uncertainty (as adwocated by Keynes and Hayek) and notes that this insight somehow got lost from economics and finance for the better part of 20 or 30 years! Quote:

I think one of the great errors we as economists made in pursuing that was that we started believing the assumptions of economics, and saying things that made no intellectual sense. The hope was that, by basing models on mathematics and particular assumptions about ‘optimising’ behaviour, they would become immune to changes in policy. But we forgot the key part, which is that the models are only true if the assumptions that underpin those models are also true. And we started to believe that what were assumptions were actually a description of reality, and therefore that the models were a description of reality, and therefore were dependable for policy analysis. With hindsight, that was a pretty significant error.

As for financial regulation, he thinks we may have to go even further in rethinking finance and banking before the crisis is over.

Quite an interesting read from a key central banker today.

 

Money and Collateral

A new IMF WP by Singh and Stella has already attracted a lot of comments on FT Alphaville and Zero Hedge blogs. They note that thee is a shortage of safe capital instruments out there, and suggest that Governments should issue more Treasuries to accommodate the shadow asking systems demand for safe and liquid assets over and  beyond what they can get inguaranteed bank deposit accounts. However, you can as well argue atshe size of he shadow banking should be reduced, for further arguments see my WP on shadow banks and the limits to central bank liquidity support http://www.levyinstitute.org/publications/?doctype=13.

The Financial System Five Years from Now

The IMF hosted a one day conference end of March on the structural challenges in banking and on shadow banking. Some of the presentations and papers have now been posted (unfortunately not all). See in particular presentation by Arnoud Boot, which gives an interesting overview of the issues, but provides more questions than answers. Andrei Shleifer et al. have a paper on shadow banking where they show how vulnerable the financial system becomes if tail risk is ignored and securitization allowed. They support some form of regulation, preferably through a leverage ratio.

Dallas Fed: End too-big-too-fail NOW

Dallas Fed Governor Richard W. Fisher has been very vocal on the TBTF issue, lastly in a speech in November last year where he wanted to “get an international accord that would break up these institutions”.

Now the annual report for 2011 is out for Dallas Fed and it is in its entirety devoted to the TBTF issue; title of the report: Choosing the Road to Prosperity – Why we must end too big to fail – NOW. Quote:

As a nation we face a distinct choice. We can perpetuate too big to fail, with its inequities and dangers, or we can end it. Eliminating TBTF won’t be easy, but the vitality of our capitalist system and the long-term prosperity it produces hang in the balance.

Two very interesting conferences

INET is hosting its second conference in Berlin shortly: Paradigm Lost: Rethinking Economics and Politics

The program is broad with a host of good speakers. By invitation only, but they usually post a lot of video.

Levy Institute will also host its 21st Annual Hyman P. Minsky Conference: Debt, Deficits, and Financial Instability at around the same time in NY City

with Gillian Tett, Claudio Borio, Andrea Enria, Peter Praet, Christine Cumming, Martin Wolf, Joseph Stiglitz among others.

Should be greatly interesting! Will keep you posted. Conference website is here.

Shadow banking in all channels

Shadow banking was the theme of a recent speech by FSA chairman Adair Turner. He noted in the Cass Lecture 2012 that (p. 21)

“the shadow banking system can create forms of ‘private money’ held either by the non-financial real economy or by intermediate financial institutions, in a fashion analogous to the banking system’s own creation of deposit money. And wherever there is maturity transformation and private money creation, there is a potential for runs. 

And to … make the banking system safe we will need to control the extent to which banks can provide such liquidity insurance to shadow banks. 

A key issue is whether shadow banks should be regulated as ordinary banks, and specifically whether they should have access to central bank liquidity facilities. Here the views are split among academics and policy makers.

The EU has issued its own Green paper of shadow banks and will host a conference on the topic end of April.

The IMF held a conference on the data needs of supervising shadow banks last fall: Casting Light on Shadow Banking: Data Needs for Financial Stability. The video is quite interesting, especially Paul Tucker from BoE, as usual very to the point.

The IMF hosted another regulatory seminar last friday March 23 (same time as the Fed conference, se previous post) on “The Financial System Five Years from Now”. No papers on the web yet, but program is posted here. Seems like an interesting day, with Buiter, Tarullo, Boot and Blanchard.

An interesting paper on Shadow banks posted last fall on the Harvard Law School Forum, called Shadow Banking and Financial Regulation. Short and to the point.

And there will be more coming. G20 and FSB has shadow banking (together with liquidity and trading book) on their agenda this summer, so expect much more on shadow banking in the months ahead.

And, if you want to really know what to do with the shadow banking problem, there will be a good working paper coming up shortly on the Levy Institute’s website. Should be up some time early April. Title: Shadow banking and the limits to central bank liquidity support. 

Goodhart on how to prevent another banking crisis

Charles Goodhart and Enrico Perotti have an interesting VOX note on “Preventive macro prudential policy”. They suggest a five step PCA-like policy response with emphasis on liquidity and punitive charges for non-compliance with the Net Stable Funding ratio. National supervisors should be empowered to charge “prudential risk surcharges” on the gap between the banks’ current liquidity position and the new Basel III norms.

I am not so sure about the novelty of this, or how it would work. It resembles the old PCA framework, although transferred to a liquidity framework. Still interesting to read and could form the basis for some supplementary PCA reactions to the current capital based system.

For a review of the US experience with their PCA system during the latest crisis, see this report from the US Financial Stability Oversight Council. It was issued late 2011, but is still relevant for the ongoing discussion on how to prevent another banking crisis.