Slides accompanying Adair Turner's 16/3/2011 speech

8/7/2019 Slides accompanying Adair Turner's 16/3/2011 speech

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1

Ideal equity ratios higher than Basel III

TBTF: making banks resolvable; necessary but notsufficient

Markets as important as institutions; shadow banking asimportant as banks

The fundamental issues

Debt/equity balance How much maturity transformation

Four implications


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2

IMF estimates of public support costs in 2008-2009financial crisis

Source:IMF: A fair and substantial contribution by the financial sector, June 2010

Advanced

economies

Emerging

economies

Pledged Utilised Recovery Net directcost

6.2 3.5 0.8 2.8

0.8 0.3 - 0.3

% of GDP


3/28

3

Growth in lending and nominal income:UK 2005 2010

-6

-4

-2

0

2

4

6

8

10

12

14

Q1

2005

Q3

2005

Q1

2006

Q3

2006

Q1

2007

Q3

2007

Q1

2008

Q3

2008

Q1

2009

Q3

2009

Q1

2010

Q3

2010

Q1

2011

Q3

2011

Q1

2012

%changeyear-on-yea

Nominal GDP (%YoY)

Private debt stock (%YoY)

Leverage increased

through the boom


4/28

4

Credit and asset price cycles

Expectation offuture asset price

increases

Increased creditextended

Low credit losses: high

bank profits Confidence reinforced Increased capital base

Increased assetprices

Increased lendersupply of credit

Favourableassessments of

credit risk

Increasedborrower demand

for credit


5/28

5

Minimum bank equity ratios: Basel II to Basel III

2% 7%

Riskweighted

assets

Total assets

Estimatedriskiness, e.g.

SME 100%Mortgages 15%

Riskweighted

assets

Requiredequity

Basel II Basel III

2%


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6

Costs and benefits of higher bank equity capital

Increased cost ofcredit intermediation

Reduced likelihoodof financial crises

David Miles et al: Optimal Bank Capital

Martin Hellwig et al: Fallacies, IrrelevantFacts and Myths in the Discussion of Capital

Regulation

Distinguish social from private costs

Consider low probability extreme events

Focus on total systems not specificinstitutions

Costs:

Benefits:

Vs

Key insights from:


7/28

7

UK banks leverage and real GDP growth

Source: David Miles, Jing Yang and Gilberto Marcheggiano, Optimal Bank Capital, External MPC Unit, DiscussionPaper No. 31

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

1880 1900 1920 1940 1960 1980 2000

5

10

15

20

25

30

35

40

Real GDP growth

(10 year m.a.)

Leverage (rhs)


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8

Mechanisms to increase loss absorption capacityand market discipline

Capital surchargeand/or sub debtconvertibility

Resolvability &statutory bail-in

Increase role ofloss-absorbingcapital

Resolutionprocedures whichcan rapidlyimposelosses/conversionon all liabilities (toextent required)

Insureddepositors

Non-insureddepositors

Interbank & othercounterparties

Senior debt

instruments

Subordinateddebt & Preferred

stock

Commonequity

Insureddepositors



Senior debt

instruments


stock

Commonequity


9/28

9

Mechanisms to increase loss absorption capacityand market discipline

Bail-inable seniordebt

Capitalsurchargeand/or sub debtconvertibility

Resolvability &statutory bail-in

Increase role ofloss-absorbingcapital

Smooth resolutionwithout disruption

Resolutionprocedures whichcan rapidlyimposelosses/conversionon all liabilities (toextent required)

Insureddepositors



Senior debt

instruments


stock

Commonequity

Insureddepositors



Senior debt

instruments


stock

Commonequity

Reserve army of capitalto cover extreme events

OR


10/28

10

Current initial investor base for UK bank senior debt

12%

12%

25%

50%Insurance

Other

Other banks

Fund Manager

Source: Broad estimates from firm information


11/28

11

Frequency distribution of bank bond payouts

100% of principaland due interest

Observed in good times100%

Not observed ingood times

0


12/28

12

Financial firms CDS and share prices

Exhibit 1.27: Composite Time Series of Select Financial Firms' CDS and share prices

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

Dec02

Apr03

Aug03

Dec03

Apr04

Aug04

Dec04

Apr05

Aug05

Dec05

Apr06

Aug06

Dec06

Apr07

Aug07

Dec07

Apr08

Aug08

Dec08

AverageC

DSSpreadinPe

rcent

-

0.50

1.00

1.50

2.00

2.50

MarketCapIndex

CDS SHARE-PRICE-ADJUSTED

Firms included: Ambac, Aviva, Banco Santander, Barclays, Berkshire Hathaway,Bradford & Bingley, Citigroup, Deutsche Bank, Fortis, HBOS, Lehman Brothers, MerrillLynch, Morgan Stanley, National Australia Bank, Royal Bank of Scotland and UBS.

CDS series peaks at 6.54% in September 2008.Source: Moodys KMV, FSA Calculations


13/28

13

Development of the crisis: 2007 2008

Bear Stearns hedge funds

Major losses by market neutral hedge funds

Carlyle Capital and Peloton Hedge Funds closed

Liquidity and solvency problems at off-balance sheet SIVs

Stresses at MMMFs: Reserve Primary Fund breaks the buck

Liquidity run in repo and other secured funding markets

Hedge fund deleveraging and asset sales exacerbate

downward spiral of asset values

June 2007:

August 2007:

February 2008:

Autumn 2007 toMid 2008:

Summer 2008:

August toOctober 2008:

Late autumn

2008:


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14

US financial sector assets

0%

50%

100%

150%

200%

250%

300%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Banks MMMFs

GSE Agency and GSE- Mortgage Pools

Issuers of ABS Finance Companies

Security Broker-Dealer Funding Corporation


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15

Traditional non-bank credit intermediation

Corporates

Households

Households

Corporates

Government

Banks

InsurancePensionsOther

DirectNon-intermediated

Leverage

Maturitytransformation

Not leveraged

Little maturitytransformation


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16

Credit intermediation via the shadow banking system

Corporates

Households

Households

Corporates

Government

InvestmentBanking /

Prime brokers

SIVs &Conduits

MMMFs

Multi-stage

leverage andmaturity

transformation

Securitisation

HedgeFunds

Corporates

Households

Households

Corporates

Government

InvestmentBanking /

Prime brokers

SIVs &Conduits

MMMFs

Multi-stage


transformation

Multi-stage


transformation

Securitisation

HedgeFunds


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17

Credit intermediation via the shadow banking system

Extensivelyinterconnected via repo

market

Investmentbanks

SIVs &ConduitsMMMFs

Securitisation

HedgeFunds

Banks

Corporates

Households

Households

Corporates

Government


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18

NASDAQ: 1995 2002

0

1000

2000

3000

4000

5000

6000

02/01/95

02/07/95

02/01/96

02/07/96

02/01/97

02/07/97

02/01/98

02/07/98

02/01/99

02/07/99

02/01/00

02/07/00

02/01/01

02/07/01

02/01/02

02/07/02

1995 1996 1997 1998 1999 2000 2001 2002

Source:Datastream


19/28

19

Greek sovereign debt and cost of borrowing

Greek 10-year spread to bunds

0

200

400

600

800

1000

2005

2006

2007

2008

2009

2010

2011

Source:

Greek general government gross debt as % of GDP

80

90

100

110

120

130

140

150

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Forecast

Source: IMF World EconomicSource: Datastream

% GDPBasis points


20/28

20

Maturity transformation

Liquid Assets

Equity/debtcapital

LoansDeposits&

shorttermdebt

Bank based

Market based

Corporates

Households

Corporates

Deposits

Government

Debt markets

Equity markets

Liabilities Assets

Corporates

Deposits

Government

Corporates

Households


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21

Household deposits and loans: 1964 2009

Source:Bank of England, Tables A4.3, A4.1

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

%of

GDP

Securitisations and loan transfers Deposits Loans


22/28

22

Holdings of US MMMF Shares by Sector

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1980 1985 1990 1995 2000 2005 2010

Other

Rest of the World

Insurance Companies

Pension FundsFunding Corps

Non-Financial Business

H'Hold

Source:US Flow of Funds


23/28

23

Financial institutions, corporate bond and CPissuance

1991-1994 1995-1999 2000-2004 2005-2010

10 years

36%48%

63% 61%

28%

26%

22% 24%26%19%

11% 10%10% 7% 4% 4%

Total issuances$ billion 768 2823 6410 16281

Source:McKinsey Global Institute: Farewell to Cheap Capital? The Implications of long-term shifts in global investment andsaving, December 2010


24/28

24

A capital adequacy and liquidity trade-off?

Liquid

assets

Debt ofaverage

maturity 6months

Equity

Loansof

averagematurity1 year

95 90

10

5

Liabilities Assets

80 95

20

5

Loans ofaverage

maturity1 year

Liquid

assets

Debt ofaverage

maturity1 month

Equity

Liabilities Assets

Which is riskier?


25/28

25

Typical haircuts on term securities financing% for prime counterparties

June 2007 June 2009

Prime MBS:

AAA rated

AA and A rated

4

8

10

~ 100

Asset backed securities

10 25Structured products

(AAA)10 ~ 100

Investment Grade Bonds

AAA and AA rated

A and BBB rated

1

4

8

10

Source:CGFS Paper No. 36 The role of margin requirements and haircuts in pro-cyclicality, March 2010


26/28

26

Measures of increasing financial intensity

1

929

1

935

1

941

1

947

1

953

1

959

1

971

1

977

1

983

1

990

1

996

2

002

2

007

10%

50%

100%

150%

200%

250%

300%

1

929

1

935

1

941

1

947

1

953

1

959

1

965

1

971

1

977

1

983

1

990

1

996

2

002

2

007

10%

50%

100%

150%

200%

250%

300%

1

929

1

935

1

941

1

947

1

953

1

959

1

971

1

977

1

983

1

990

1

996

2

002

2

007

10%

50%

100%

150%

200%

250%

300%

1

929

1

935

1

941

1

947

1

953

1

959

1

965

1

971

1

977

1

983

1

990

1

996

2

002

2

007

10%

50%

100%

150%

200%

250%

300%

Hous

ehold

Corpo

rate

Fina

ncial

0

50

100

150

200

250

300

350

400

450

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

$T

r

OTC interest rate contracts, notional amount outstanding

0

100

200

300

400

500

600

700

800

900

1,000

1,100

1977

1982

1987

1992

1997

2002

2007

$bn

Global nominal GDP, $bn Global FX turnover, annual, $bn Global exports, $bn

US debt as a % of GDP byborrower type

Growth of interest ratederivatives values, 1987-2009

FX Trading values & world GDP1977-2007

Global issuance of asset-backed securities

$Tr

n


27/28

27

Share of the financial industry in US GDP

%

Source: Andrew Haldane, What is the contribution of the financial sector: Miracle or mirage?, Chapter 2, The Future ofBanking, LSE Report 2010


28/28

28

Historical excess wage in the US financial sector

Source: Andrew Haldane, What is the contribution of the financial sector: Miracle or mirage?, Chapter 2, The Future ofBanking, LSE Report 2010

Slides accompanying Adair Turner's 16/3/2011 speech

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