Global Regulatory Issues: Tokyo Roundtable, February 2012 Adrian Blundell-Wignall Special Advisor to the Secretary-General of the OECD on Financial Markets (The views presented here are my own & do not reflect those of the OECD or any of its member governments.) February, 2012
43
Embed
Global Regulatory Issues: Tokyo Roundtable, February … · 2016-03-29 · Global Regulatory Issues: Tokyo Roundtable, February 2012 ... Policy Advantages Disadvantages FISCAL CONSOLIDATION,
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Global Regulatory
Issues: Tokyo
Roundtable, February
2012
Adrian Blundell-Wignall
Special Advisor to the Secretary-General of the OECD on Financial Markets
(The views presented here are my own & do not reflect those of the OECD or any of its member governments.)
• The „Greece problem‟ needs to be resolved: transfers & guarantees required.
• No destructive fiscal-ism: growth first, compact achievement later. Structural reforms: bank restructuring and recapitalisation; labour and product market competition; and pension system reform.
• Bank recapitalisation based on a proper cleaning up of balance sheets and resolutions. This can only be achieved with transparent accounting. Over €400bn needed (5% leverage ratio) plus some for losses.
• Investment and retail banking have to be separated. Depositor insurance cross-subsidises high-risk-taking businesses. These traditional banking activities should be immune to sudden price shifts in global capital markets. These policies will improve, not diminish, the funding of domestic SME‟s on which growth depends.
• EFSF/ESM resources of €500bn are not enough: more than € 1tn needed (borrowing needs and bank recapitalisation). More paid in capital and leverage ability may be needed—the €500bn limit to the ESM should not be consolidated with the €440bn resources of the EFSF. If these structures as envisaged can‟t raise enough funds from private investors—as seems likely—then other funding sources will need to be brought in: (a) a bank license to the EFSF and credit from the ECB (and increasing leverage); (b) the IMF is a „bank‟ and the ECB could lend to them the appropriate sums; (c) sovereign wealth funds could be cajoled with appropriate guarantees (possibly via the IMF) to provide the funds.
The Financial Crisis, &
Regulation
Source: OECD
12
• Basel.
• Leverage.
• GSIFI‟s, dealing with investment banking and counterparty risk.
Figure 10: Risk and the Crisis
Source: OECD 13
• The fundamental cause of the crisis was the under-pricing of risk.
• There are always 2 basic causes of excess risk: (1) too much leverage; & (2)—for given leverage—increased dealing in high risk products.
• Risk-weighted asset optimisation makes a mockery of the Basel tier 1 rule. Banks model their own risk & anyway can use derivatives to alter the risk characteristics of assets to which the risk weights apply.
• The OECD has consistently argued for (1) a leverage ratio and (2) the separation of retail & investment banking from the outset of the crisis.
Figure 11: Structural Trends & the Current
Crisis
Source: OECD
14
• Once or twice in a career secular trends in innovation & structural change collide with institutional arrangements & regulations creating conflicts in policy objectives & market volatility so great that its is capable of bringing down the system.
• For banking policy has allowed too much leverage & (until now in the UK) has failed to take seriously the need to separate retail from investment banking.
• Securitisation, OTC derivatives, repo financing, & re-hypothecation pyramids, inter alia, have contributed to “complete markets” in bank products. There is more volatility and greater inter-connectedness.
Source: BIS, Datastream, World Federation of Stock Exchanges, OECD 19
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0Total
Primary Securities
Derivatives
Figure 17: What Banks Do
Source: Bank Reports, OECD
20
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00 % Deriv/TA
Loans/TA
FV Sec./TA
Deposits/TA
Figure 18: CDS the Atomic Bomb Graph
Source: OECD
21
• One of the most urgent things to do in Europe (& elsewhere) is to introduce NOHC legislation to facilitate the quarantining of risk from different parts of a financial group. Bravo Vickers.
Notional €100m
Probability of Default (& 50% Recovery Rate)
After 4 Periods
0.99 €45.2m
0.76 €33.3m
0.34 €11.7m
0.19 €4.6m
Figure 19: The AIG CDS Payouts
Source: GAO, AIG, OECD
22
Institution
Collateral
postings for credit
default swapsa)
Payments to securities
lending counterpatiesb) Total
As a share
of capitalc) at
end-2008
Goldman Sachs 8.1 4.8 12.9 29.1%
Société Générale 11 0.9 11.9 28.9%
Deutsche Bank 5.4 6.4 11.9 37.4%
Barclays 1.5 7 8.5 20.0%
Merrill Lynch 4.9 1.9 6.8 77.4%
Bank of America 0.7 4.5 5.2 9.1%
UBS 3.3 1.7 5 25.2%
BNP Paribas … 4.9 4.9 8.3%
HSBC 0.2 3.3 3.5 5.3%
[memo: Bank of America after its merger with Merrill Lynch] 12 [18.1%]
In USD billion
Figure 20: The Logic of Separation
Source: Datastream, OECD 23
• A retail bank with a leverage ratio is
safe & boring—boring is good for
unsophisticated investors (but not
good for bankers profits).
• Deposit insurance applies to the
boring retail bank only, and there
should be no TBTF cross
subsidisation of the IB.
• Boring bank goes on lending to
households & SME’s regardless of
what happens in the IB—prices of
products determined in global
markets.
• IB has more limited capital & no
guarantees, & no favoured Basel
status—tough initial & variation
margin requirements & high quality
capital via market pressure. The cost
of capital for high risk activities goes
up.
Figure 21: Firewall NOHC Structure
Source: OECD 24
ALTERNATIVE CONGLOMERATE STRUCTURES
PARENT (C) NOHC (siloed cap.)
Capital market activity Equity 100 Equity 100 Equity 100
SUBSIDIARIES Comm. Bank Invest. Bank Comm. Bank Invest. Bank Comm. Bank Invest. Bank
Leverage ratio (assets/equity) 41 times equity 20 times equity 18 times equity
Unweighted capital ratio (common equity), % 2.5 5.0 5.6
max. loss in % of equity 191 151 60
Return on equity, % 41 36 18
a) A conglomerate "too big to fail" (TBTF), thus with implicit government guarantee; no restrictions on leverage ratio imposed.
b) A conglomerate "too big to fail" (TBTF), thus with implicit government guarantee; but assuming a group leverage restriction of 20 times equity is imposed.
c) Profits are assumed as 1% return on assets (ROA; balance sheet total) for all cases except for the IB in case B where profits are assumed to be 3% ROA activities
(due to riskier IB compensating for the reduction in ROE caused by restrictions on leverage).
(A) TBTFa) (B) TBTF & levg.restr.b)
Figure 22: Firewall NOHC Structure
Source: OECD
25
SIFI EXPOSURE TO LOSS BEFORE SEPARATION
UNEXPECTED TRADITIONAL
VOLATILITY BANKING
EVENT (STD. DEV.'s) (Amortised Cost Accounting)
5
SECURITIES TRADING
PRIME BROKING
4 OTC DERIVATIVES
(Fair Value Accounts)
3
2
1
Loan loss: Traditional Banking
0 Bank Capital 5%
Leverage Ratio
POST SEPARATION
Retail Bank
5
4 Separated IB
Little Capital/Counterparties
Require 100% Collateralisation
3
SECURITIES TRADING
PRIME BROKING
2 OTC DERIVATIVES
(Fair Value Accounts)
1
0
Figure 23: Some Fallacies of Hasty
Generalisation
Source: OECD
26
• „I always give a one word answer when someone tells me it is safer to have stand-alone investment banks—LEHMAN‟.
(A lawyer from London at the recent OECD CMF meeting)
Lehman did not operate in the NOHC separation regime and benefitted from favourable Basel treatment as a bank in its interactions with other banks. No cross subsidisation in the new regime.
• „The removal of Glass-Steagall rules didn’t cause contagion risk. We have had universal banks here in Europe for centuries, and no problems have arisen before the US subprime crisis caused a headache for everyone’.
(A senior European policy maker)
Prior to “complete markets” and greater „interconnectedness‟ universal banking was less dangerous (& Glass-Steagall-like rules less needed) than is the case now. Large scale co-mingling of fair-value-through-profit-or-loss capital market banking products with amortised cost accounting traditional bank products, following decades of innovation & poor regulation has changed all of that.
Figure 24: NOHC Legislation Australia
Source: OECD
27
• March 1997 Wallis Review recommends NOHC: best method to quarantine entities in a group containing an ADI (to protect against creditors of one entity seeking to pursue the other entities of a group).
• 1998 Financial Sector (Shareholdings) Act amends the 1959 Banking Act to permit NOHC‟s.
• No adoption due to regulatory & tax complications (impediments under the Corporations Act 2001, & income tax law), so the Financial Sector Legislation Amendment (Restructures) Bill 2007 was passed.
• Restructure instrument: to grant relief to the specific statutory impediments to NOHC affiliates complying with the requirements of law.
• Internal Transfer Certificates: by APRA, to facilitate the rearrangement of assets & liabilities of the different activities into their separate business lines.
• Income Tax Assessment Act 1997 amendments: to the consolidation rules & capital gains tax aspects that were impediments to restructuring.
• Macquarie Bank adopts NOHC in 2007—it saves the bank in the crisis.
ETF holding Buys stock & lends it Investors deposit Cash on Sale Stock
100 100 Loan 100 100 100
Investor wants to withdraw deposit today, but the stock loan is not due. Borrows from a liquidity provider.
collateralising the stock. What happens in a liquidity crisis? What happens if the borrower fails?
SYNTHETIC ETF, The Risk Is Even Higher
COLLATERAL BASKET
(unrelated to ETF market)
Collateral
Cash Basket
Return
INVESTOR Cash ETF PROVIDER Cash INDEX ETF S&P500
S&P ret S&P ret
Collateral
S&P ret. Basket
Often the same Return
bank.
SWAP COUNTERPARTY
Figure 39: Summary of Financial Reform Process
Source: OECD
42
• At the FSB there has been a strong focus on progress with reform: Basel III compliance; raising more capital; getting more OTC derivatives centrally cleared on platforms; and improving the resolvability of SIFI‟s. Country reviews are going on—recently Canada and Switzerland. In these reviews, they look at what countries are doing individually, in addition to internationally negotiated things like Basel III.
• The US, the EU and Japan are working together on clearing platforms for OTC derivatives. But these products are traded globally, raising questions that some countries in Asia will have banks exposed to platforms over which they have no control.
• Switzerland has focused on holding more capital than required and is dealing with resolvability in a unique way—a capital rebate if its banks can demonstrate resolvability.
• Canada, the United Sates and Switzerland (to be implemented next year) have a leverage ratio (not based on risk weighted assets that runs alongside the Basel risk-weighted approach.
• Separately, the Vickers inquiry in the UK has recommended separation of retail and investment banking and this has been accepted by the government.
• The US Dodd-Frank bill has looked to ban proprietary trading and certain swap transactions must be separated and (by law) will not be bailed out in the event of a problem.
Figure 40: What is lacking
Source: OECD
43
• What is clearly lacking on these crucial issues is international consistency in what countries do and what they might be exposed to. Without this consistency, issues will continue to arise about regulatory arbitrage and business migration from more to less controlled jurisdictions. Non-financial businesses are also concerned about these inconsistencies and what it will mean for them.
• Asia could risk becoming the recipient region for this less regulated search if it is not careful.
• A lot more consistency would come about if countries would begin to focus more on the 2 key proposals that the OECD has backed from the outset of the crisis:
• 1. A leverage ratio, based on more equity, of 5%. The US, Canada and Switzerland are already on board and Europe needs to join. As different accounting systems apply this needs to be resolved, and more transparency generally about hidden losses and the real capital needs of banks have to be solved.
• 2. Formal separation of traditional banking (retail) from investment banking as now accepted by the UK. This helps solve the resolvability issue.