Is the banking system safer, simpler and fairer?
(The writer, a Malaysian and a former central banker in Malaysia and Hong Kong)
THIS week in Singapore, fresh from the G20 meetings in Brisbane, Bank of England governor Mark Carney delivered a major speech outlining the future of financial reform.
As current chairman of the Financial Stability Board (FSB), tasked with coordinating global financial stability efforts, he patted himself on the back that the Brisbane meeting had completed the monumental task of designing a post-crisis system of prudential regulation. The tough job ahead is implementation.
Congratulations – seven years after the failure of Lehmans, the world's hard working central banks and regulators have finally agreed on a set of regulations that may solve the last crisis, but may not solve the next one.
I must say that in carefully reading Governor Carney's speech, I felt rather staggered that he can declare that the global financial system is (not will be) safer, simpler and fairer, when the facts are pointing in the other direction.
Is it safer?
On the adequacy of bank capital, he pointed out that the capital shortfall was much smaller at £15bil at the end of 2013, compared with £150bil two years ago. The European Commission (EC) Financial Stability and Integration Report (April 2014), reported that between 2008 and June 2013, 400 billion euros out of the total European bank capital increase of 630 billion euros corresponded to increases in inter-bank positions and only 230 billion euros represent fresh capital injected from outside the banking system.
Don't forget that the banks were fined over US$150bil for misdeeds, half of which was for breaking sanctions, which was more for geo-political reasons than for putting depositors' money at risk.
On Oct 15, while the central bankers were busy in Washington DC attending the IMF annual meetings, the US Treasury market had a heart seizure that was mostly missed by the main headlines. The yield on the 10-year Treasury note moved 0.37 percentage points from peak to trough in about 30 minutes, equivalent to "flash crash" in the bond market.
No one has publicly explained what caused the sharp move, but it was probably a combination of regulations that restricted the ability of bond market makers to take a position when the market moves and the simultaneous high-speed trading on computer algorithms that triggered automatic sell signals that created the "crowded exit".
When the markets panic, liquidity disappears. It is not safer, even in the most liquid of markets.
Is it simpler?
I cannot see how the financial system is simpler when the regulations and trading models are so complex that you need either an expert lawyer and a PhD in quantum physics to decipher what is going on. The above EC report suggested that interconnectedness across banks are so high that as of December 2013 "the counterparty for 24% of eurozone banking assets (or 7.4 trillion euros) is another eurozone bank".
Furthermore, as a result of bank consolidations, the concentration of the top banks in the world is increasing rather than decreasing.
Is it fairer?
The FSB proudly announced that the Brisbane agreement on Total Loss Absorbing Capacity (TLAC) for globally systemic banks will result in these banks being resolved in the future without recourse to the taxpayer and without jeopardising financial stability. Basically, the TLAC proposes that banks should issue "coco" bonds that will convert into equity – "bail in" the bondholders when the bank fails.
As risk manager Avinash Persaud (www.piie.com/publications/pb/pb14-23.pdf) convincingly argues, these "bail-in bonds" are fool's gold. Once you tie a future failing globally significant bank to the bond market, and if the bond market also cracks up, guess who will have to come to the rescue?
The financial system as a whole has not been fair since the central banks started introducing interest rates below the inflation rate. Guess who has been subsidising the large, concentrated borrowers? The pensioners, the small savers and those who cannot afford to buy speculative assets on leverage.
Guess who has been bailing out the speculative and leveraged players with massive injections of liquidity and lowered interest rates until they reached nearly zero? The top four central banks which tripled their balance sheets to US$10 trillion between 2008 and 2014. I was truly disappointed that in a major speech by a major financial leader on the future of financial reform, the game-changing words that concern us all – "social inequality", "climate change" and "technology" did not appear at all. Instead, the solutions to building a stronger financial sector "that can deliver strong, sustainable and balanced growth for all economies" were diversity, trust and openness.
Is diversity being created if we are concentrating derivative financial transactions into central clearing platforms? Is diversity being encouraged when similar prudential and liquidity rules are being applied to investors? Can trust be generated when there is essentially very little trust between bankers who fear changes in the rules one day and being fined by bankers and regulators the next? Are we being more open when new regulations make the system more "Balkanised?"
With all due respect, the FSB has put the cart before the horse.
The world economy is like a horse (the real economy) and the cart (financial system) working together. We had a financial crisis because the horse was overleveraged and the cart was also overleveraged, with a driver punch drunk on more debt being the cure-all. When the cart breaks down, it is understandable that we try to fix the cart. But seven years later, the horse is not only weaker, but even more leveraged than before. But the driver insists that the cart becomes a Rolls Royce, with more capital, more robust and safe, trustworthy and open.
But it is the real sector horse, the engine of growth that needs more capital, not more debt. If the horse falters, the cart will also keel over, irrespective of the increases in capital and liquidity. The major reason why financial markets are at record highs in price and turnover, despite serious problems in the real economy, is unconventional monetary policy.
As a former central banker, I am more used to central bankers who are financial market referees rather than players. We can all understand that when the game gets wild, central bankers must play the role of goal keepers, but I do find it strange that central bankers playing forwards to keep the markets bubbling along can also be the referee determining the market rules.
Under these rules, an own goal is a victory.
Tan Sri Andrew Sheng is a former central banker and financial regulator.