“In summary, there is an upper limit to the amount of equity capital a financial firm could be required to hold without pressing its rate of return on equity below what history suggests is the average minimum competitive 5%. Because financial intermediation requires significant leverage to be profitable, risk, sometimes large risks, are inherent to this indispensable process. And on very rare occasions, it will break down and may require the temporary substitution of sovereign credit for private capital…

…In the late 19th Century, U.S. banks required equity capital of 30% of assets to attract liabilities required to fund their assets. In the pre-Civil War period, that figure topped 50%. When determining the levels of adequate regulatory capital, it is important to recognize that the decision is not independent of the scope of regulated bank activity. There are limits to the level of regulatory capital. A bank, or any financial intermediary, requires significant leverage to be competitive. Without adequate leverage, markets do not provide a rate of return on financial assets high enough to attract capital to that activity. Yet at too great a degree of leverage, bank solvency is at risk. To find the regulatory balance we need to seek the highest average ratio of capital to assets the banking system can tolerate before significant numbers of banks are required to raise their margin and/or shrink their size. In the years immediately prior to the onset of the crisis Pi/A averaged 0.012 and therefore inferred maximum average regulatory capital, C/A, was 0.24. If Pi/A were to revert back to the average of the first quarter century of the post-war period (0.0075) then Pi/A=0.0075 and C/A=0.15, marginally above the 12% to 14% presumed market determined capital requirements, that would induce banks to lend freely. While such calculations derive from a static model and are necessarily imprecise, they emphasize the regulatory tradeoffs between capital requirements and scope of permissive banking activities. They suggest that a targeted regulatory capital requirement of 13% to 14% leaves considerable leeway for regulators to raise capital requirements provided that in the process, the scope of banking activities is not unduly restricted.”, Excerpts from Alan Greenspan’s, “The Crisis”, March 2010

“Make no mistake about it, private bankers and their unsecured creditors don’t determine the adequacy of bank capital levels. They never have, despite articles like the one below. Why? Because the government insures/guarantees the vast majority of their liabilities (deposits) and so they have THE most important financial interest in determining bank capital levels and that’s why they and they alone set and enforce them. Clearly, pre-crisis, the government bank regulators at The Fed, FDIC, and elsewhere were horribly wrong, but it was in their interest to blame the private bankers rather than take responsibility. Greenspan’s paper (the excerpt above and elsewhere) makes clear that this blame is a lie, another part of the government’s false narrative about the crisis. Could a private banker have chosen to hold even more capital than required by the government’s bank regulators? Probably not. It’s a very competitive marketplace and as Greenspan points out, higher the capital levels, either cause you to have lower returns to investors and/or high rates to borrowers and/or lower rates to depositors. In other words, if you don’t respond to your banking competitors, and keep similar government-mandated capital levels as them, you will not be able to raise capital, raise deposits, and/or lend in a competitive manner.”, Mike Perry, former Chairman and CEO, IndyMac Bank

June 12, 2016, Donna Borak, The Wall Street Journal


Regulators to Banks: We’ll Size Up Your Risks

International regulators want to limit banks’ leeway in assessing the riskiness of their assets, a step that critics say could crimp lending, dent profits and worsen risk rather than reduce it


A number of legislators, regulators and bankers including J.P. Morgan Chase & Co. CEO James Dimon have questioned the way different banks calculate their risks. PHOTO: T.J. KIRKPATRICK FOR THE WALL STREET JOURNAL

By Donna Borak

International regulators want to limit banks’ leeway in assessing the riskiness of their assets, a step that critics say could crimp lending, dent profits and worsen risk rather than reduce it.

A committee of overseers in Basel, Switzerland, since the end of last year has proposed five different rules that would require banks to use standardized calculations instead of their own when measuring possible losses on everything from loans to interest rates to fraud.

The Basel Committee on Banking Supervision is considering a series of rule revisions as part of their effort to finalize postcrisis capital rules. Regulators agreed to spend this year addressing weaknesses spotlighted by the financial crisis, including minimizing the variance in how banks weigh their own risk in three key areas: credit risk, market risk, and operational risk.

One proposal would stop banks from calculating their own exposure to other banks, large corporations and stockholdings. Another imposes tougher capital requirements on swaps, bonds and other securities that banks plan to trade. Capital requirements often depend on lenders’ exposure to risk.

The moves reflect regulators’ frustration with varying loss estimates across banks. Some bankers also have questioned whether peers are playing down risks in the hope of boosting profit.

The 29-member Basel Committee includes representatives from the U.S., Germany, Netherlands, European Union and China. It doesn’t set banking rules directly, but makes recommendations for member countries to implement. Yet Basel rules have significant influence over how member countries regulate their banks.

Leading industry trade groups have sharply criticized the proposed changes, saying they would do more harm than good. They say the proposed rules are a de facto way to boost capital requirements beyond current levels already criticized by some executives as onerous.

“We are particularly conscious of the cumulative impact that this suite of proposals stands to have on the required levels of bank capital, and on the ability of banks to support the economy,” Andrés Portilla, an official at the Institute of International Finance, a financial industry association, wrote to the Basel Committee June 3, the deadline for comments on the rules.

The issue taps into a debate about the merits of broadly weighting assets for risk. Some maintain the approach has become overly complex and should be scrapped in favor of simpler metrics based on unadjusted measures of assets. House Financial Services Chairman Rep. Jeb Hensarling, (R., Texas) criticized the use of risk weighting in unveiling his financial-overhaul plan earlier this month. He called the approach “too complex, requiring millions of calculations” to account for banks’ capital needs.

In April, Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corp., called the practice “misleading.”

“No other industry is allowed to make these kinds of adjustments,” he added.

James Dimon, chief executive of J.P. Morgan Chase & Co., also has questioned the way different banks calculate their risks. During an investor-day presentation in 2011, he said a comparison of his bank’s risk-weighted assets with those of peers suggested the peers’ approach “can’t be accurate … I mean, obviously, someone’s using far more aggressive models.”

Basel officials maintain that too much variation across banks’ approach to weighing the risk of assets has undermined the effect of postcrisis safeguards.

Capital and liquidity buffers “can only be as reliable as the underlying risk measurement and management,” said William Coen, secretary-general of the Basel Committee in an April speech in Australia.

Mr. Coen displayed with his speech graphs showing variations in the way different banks estimated the risk weights in their portfolios, with widely varying results. “It’s fair to say that the wide discretion provided to banks in the current framework is likely a major driver of this high degree of variability,” said Mr. Coen.

Industry representatives are pushing back. Greg Baer, president of the Clearing House Association, a trade group of large U.S. banks, wrote this month in his group’s trade publication that while bank models have been criticized, “there are multiple reasons to be still more skeptical of uniform, government-devised regulatory risk assessments.”

He said, as an example, that with credit-card accounts, the rules don’t adequately account for various types of borrowers or market segments. He added that standardization would steer banks to make the same choices, potentially amplifying the losses if bets go bad.

In recent years, American regulators have tended to respond to Basel proposals with their own stricter standards, prompting complaints from U.S. executives of “gold-plating.”

Since December, the Basel Committee has revised or finalized five different proposals that each essentially would swap out banks’ calculators for regulators’ own. In addition to the rules about calculating their own credit risk from exposure to other banks, large corporations and stockholdings, policy makers are considering capping banks’ exposure to assets such as corporate debt, mortgages, and credit cards. Another proposal would tighten how banks fix the amount of capital they need to protect against possible losses from legal problems or external events like cybercrime.

“We want to give banks leeway to build their own views on risk, to sharpen risk management of their own business models. On the other hand, you don’t want this to lead you to … question the reliability of the outcomes,” said Andrea Enria, chairman of the European Banking Authority, speaking at a seminar at the Institute of International Finance in Washington in May.


Posted on June 30, 2016, in Postings. Bookmark the permalink. Leave a comment.

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