September 8, 2013 7:00 pm
Unfinished business in battle to fix the Banks
Ever since Lehman Brothers collapsed almost five years ago – the most dramatic event in an unprecedented global crisis that is still reverberating today – policy makers have laboured to fix the causes of that disaster and to pre-empt the next. Have they succeeded?
In an attempt to gauge the merit of the glut of global reforms, the Financial Times has looked back at the 34 main banks and brokers that failed in the crisis, judging the principal reasons for failure from a menu of five – low capital; weak funding structures; poor lending; poor trading investments; and misguided mergers and acquisitions. Many failed for multiple reasons, though Royal Bank of Scotland is the only institution to which all five triggers applied.
The Banks at the Nucleus of the Crisis
Any analysis of the precise causes of the global financial crisis, even after five years of reflection, is necessarily subjective. But if there were five main causes of failure, regulators can claim at least partial victory on four of them. Capital levels in the system are more than three times higher than they were before the crisis as banks pre-empt the requirements of new Basel III global standards. Financing is more stable, with far less reliance on risky short-term market funding and new incoming rules demanding banks hold minimum levels of cash and safe assets.
Those successes have emboldened regulators on both sides of the Atlantic. Banks have been chastened and their outspoken executives slapped down, or in the case of Barclays’ Bob Diamond, run out of town.
Bankers concede that supervision, after often notoriously lax oversight before the crisis, has clearly improved. “Regulation now is rightly much more intensive and intrusive and the supervisory teams are much better,” says Richard Meddings, finance director at Standard Chartered in London.
According to the FT’s analysis, this was the single biggest factor in the crisis. Of the 34 big banks that failed, three-quarters succumbed in large part because of the poor quality of basic lending – in particular to residential and commercial mortgage customers.
There is little that the authorities can do directly in a market economy to curb foolish lending practices by private sector banks. But reformers argue that a laser focus on capital, which can absorb losses, is the essential way to protect the system from further harm.
This was the first issue tackled by regulators in the wake of crisis, with big banks today required in practice to hold equity capital equivalent to 10 per cent of their assets weighted for risk. But in recent months reformers have launched another offensive on capital, conscious that risk weightings are fallible and can in any case be massaged to reduce capital requirements.
Several countries, notably the US, the UK and Switzerland, have begun initiatives to boost the amount of equity banks hold relative to their overall unweighted assets. This leverage ratio – as low as 2 per cent at many banks in the boom years – meaning balance sheets were geared 50 times – will in future need to be as high as 6 per cent under US reform plans.
The expected wind-down of bond-buying under QE has already hurt banks by pushing down the value of bonds on their balance sheets. A secondary threat comes from the prospective end of cheap central bank funding in the eurozone in a little more than a year.
“The challenge will be to balance various regulatory initiatives with the realities of unwinding quantitative easing and fostering economic growth,” says Jim Cowles, head of Citigroup’s operations in Europe.
Many are furious about onerous pay reforms, particularly the incoming EU ban on bonuses that are more than double annual salary. They resent the US Volcker rule and its constraints on using the bank’s own money for trading purposes.
And there is growing irritation about what many see as a series of witch-hunts against banks over past misdemeanours, from insurance mis-selling in the UK to mortgage product mis-selling in the US. “Regulators now appear to be on a mission of retribution,” says Bill Michael, head of financial services at KPMG UK.
In particular, worries persist about the complexity and size of banks nowadays, a problem that has, if anything, intensified. “The banks that were deemed too big to fail five years ago are now even bigger,” says Richard Portes, professor of economics at the London Business School.
JPMorgan Chase, for example has ballooned, boasting assets of $2.4tn following organic growth and crisis-triggered acquisitions of Bear Stearns and Washington Mutual, compared with only $1.6tn in 2007. The UK’s Lloyds Banking Group, after its government-sanctioned takeover of HBOS, is more than twice the size it was before the crisis, with a balance sheet of nearly £880bn. In 2007, there were only six banks in the world with assets of more than $2tn. Today there are 13.
In the US, there has been deadlock on many elements of the Dodd-Frank reforms, much to the irritation of President Barack Obama. A campaign to restore Glass-Steagall, the repealed 1930s legislation that barred banks and brokerage houses from combining, has made little headway.
In tandem, policy makers in Europe and the US are working on the concept of predefined “bail-ins” of bondholders in times of crisis. Optimists cite examples of recent failures, such as the Netherlands’ SNS Reaal, which included a bail-in of bondholders alongside nationalisation.
Overall, though, progress on the topic is laborious and few believe that banks will shrink much any time soon, whatever reformists might like to think. “Size is too simple a metric [anyway],” says Douglas Flint, chairman of HSBC. “It really doesn’t matter from a systemic point of view whether you have four banks or forty banks in a market. It’s the system’s asset concentration – principally in government debt and in mortgage debt – that can be dangerous.”
Copyright The Financial Times Limited 2013.
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