Commentaries

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What banks can learn from hedge funds

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Should the banking industry look more like the hedge fund sector? That’s the surprising suggestion made last week by two Bank of England officials.

In a fascinating paper, Piergiorgio Alessandri and Andrew Haldane explore the level of public support given to banks in the crisis and the problem of institutions that are too big too fail. Their main point is that if this issue is not addressed it will lead to new crises and even bigger bailouts in the future – a state of affairs they describe as a “doom loop”.

But the most eye-catching passage is a suggestion that banks have a lot to learn from hedge funds:

It may be coincidence that the structure of the hedge fund sector emerged in the absence of state regulation and state support. It may be coincidence that the majority of hedge funds operate as partnerships with unlimited liability. It may be coincidence that, despite their moniker of “highly-leveraged institutions”, most hedge funds today operate with leverage less than a tenth that of the largest global banks. Or perhaps it might be that the structure of this sector delivered greater systemic robustness than could be achieved through prudential regulation. If so, that is an important lesson for other parts of the financial system.

Do banks really need to hoard liquidity?

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That’s the provocative question posed by Willem Buiter. His latest, characteristically lengthy, blog post tackles the regulatory vogue for forcing banks to hold much greater reserves of liquid assets – in practice, government bonds.

Buiter’s missive follows new rules from Britain’s Financial Services Authority, which will force banks to increase their reserves of government bonds by more than a third. The rules have been met with predictable bleating from the industry, which accuses the regulator of undermining Britain’s competitiveness and promoting the fragmentation of the global financial system. Another concern is the FSA’s handling of the transition.

RBS issue must be on commercial terms

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Britain’s state-controlled banks appear to be playing a game of tit-for-tat. Lloyds Banking Group last week admitted it was looking for ways to reduce its exposure to the government’s insurance scheme for toxic assets. Now it turns out that Royal Bank of Scotland is also sounding out investors about tweaking its own involvement in the scheme.

That is where the similarities end, however. RBS is being much less ambitious than Lloyds. It still wants the government to insure all of the assets it agreed to put into the scheme in the winter. It just wants to pay some of the premium in cash rather than its own equity. This may look a superficially attractive way to de-risk the tax-payer’s huge exposure to bank equity, but the government should think hard before accepting.

The Fed’s phony war on bonuses

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Any attack on bank bonuses is going to be a reliable crowd pleaser. So a Federal Reserve proposal to meddle in Wall Street pay would make a good deal of political sense.

But Fed officials are almost certainly aware that this populist flourish will do little to control risk-taking or stabilize the financial system. There are far simpler and more effective ways to clamp down on reckless bank behavior than seeking to micro-manage bank pay structures.

Banking? Keep it simple stupid

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In 1873, Walter Bagehot wrote that “the business of banking ought to be simple; if it is hard it is wrong.” He would have struggled to recognize today’s banking system.

It is not just ever more ornate derivatives that bend the mind. Financial firms themselves have become fabulously complicated. Citigroup lists 2,061 subsidiaries and affiliates while the institutional chart of JPMorgan Chase is 267 pages long.

The social cost of runaway bank pay

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If only the economy were bouncing back as fast as banking compensation.

Even as the first anniversary of the collapse of Lehman Brothers draws near, bankers and traders are now grabbing a larger share of their institutions’ net revenue than they did during the boom years. The leading U.S. banks are on track so far this year to pay their employees $156 billion — more than in sunny 2006.

Politicians have focused mostly on whether the bonus structure can be changed to discourage bankers from making reckless bets with their shareholders money. But a bolder solution to excessive banking pay is necessary. It starts with a simple question: Are bankers paid too much? The answer is a resounding yes.

from Margaret Doyle:

Lloyds calls bottom of loss cycle – early?

Lloyds Banking Group's outgoing chairman, Victor Blank, foretold "exciting prospects [and] long-term success" as the bank wrote off 13.4 billion pounds in bad debts, contributing to an overall 4 billion pound loss. The group's assertion that its loan impairments have peaked -- well ahead of when historical precedent suggests -- may also prove a hostage to fortune.
Blank's remarks and chief executive Eric Daniels' thanks to him for his "significant contribution" had an air of surrealism about them. Blank, after all, cooked up the hasty takeover of HBOS that scuppered the formerly cautious Lloyds last autumn, forcing it into government arms. Daniels did nothing to stop him.
Blank is bowing out after losing the confidence of UK Financial Investments, the body that looks after the government's 43 percent stake in the bank. However, UKFI's boss, John Kingman. still defends Daniels, whose old-style banking skills are seen as key to digging Lloyds out of this mess.
The extent of the damage of the HBOS deal is evident from the numbers. No less than 80 percent of the impairments come from its book, which was laden with overvalued real estate, both commercial and residential. Indeed, the cost of bad HBOS loans in the first six months of the year exceeds the amount it spent buying the bank.
In Lloyds' defence, it is dealing aggressively with Blank's unfortunate legacy. It is working through the loan book and identifying the real dross that will go into the Government Asset Protection Scheme (GAPS). Three quarters of the assets affected by the impairment charge are ear-marked for the GAPS.
Moreover, all of the group's new lending (which is significant -- gross mortgage lending, for example, is 18 billion pounds, maintaining its market share at 27 percent), is now done under Lloyds stricter criteria. The group is winding down the "specialist", e.g. self certified, and buy-to-let mortgage categories that proved so tempting to amateur property barons.
Lloyds is also crunching through the integration at top speed. It has always been known for being tight on costs. Indeed, it is a bitter joke in the industry that it drip-feeds job losses -- rather than declaring its target for cuts -- in an effort to avoid political fall-out. Staff numbers fell by 2,619 in the first half, to 118,207. More are surely to come with the group targeting an annual improvement of a full 2 percentage points in its cost income ratio for the next few years.
On the funding side, Lloyds is increasing the maturity of its funding -- despite the higher costs -- though are still concerns the enlarged bank remains overly dependent on wholesale funding which is currently being supplied by central banks and
government guarantees.
So far, each of these initiatives has been dwarfed by the sheer scale of HBOS losses. Normally banking losses peak a year or so after the trough of the recession, which suggests any turning point is at least twelve months away.
Lloyds reckons that the property focus of the HBOS books means that losses have peaked much earlier than they would otherwise have done. The GAPS should also help shield Lloyds from mounting losses.
However, general corporate defaults are likely to rise, as are nemployment-related defaults on unsecured debt. If Lloyds' prediction proves correct, it will have taken a step towards rebuilding its battered credibility. Who knows? Daniels may be able to keep his job after all.

Time for Britain to close the GAPS

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Britain’s asset protection scheme, invented to protect the banking system, is morphing into a bureaucratic monster. It’s time to kill it off. Though state support is still needed, there are simpler ways for the government to prop up its ailing lenders.

More than seven months after it was conceived, and five months after Royal Bank of Scotland and Lloyds Banking Group signed up to use it, details of the APS have still not been agreed. The sheer task of sifting through 585 billion pounds worth of loans to be insured by the government means any final agreement is months away.

Starting small

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At least one country is grabbing the bull by the horns and pledging a radical overhaul of its financial system.

“The world is asking for more transparency, higher standards, more controls, more precise rules, “ notes the chairman of this nation’s central bank.

from Margaret Doyle:

HSBC tortoise will outpace Barclays hare

Barclays’ and HSBC’s interim results are a study in contrasts. Barclays has used the credit crunch to make a bet-the-farm move into the investment banking big-league, a bet that has so far paid off. HSBC, in comparison, chastened by its flawed move into the US subprime market, has returned to its conservative roots.

John Varley, Barclays’ chief executive, gives the usual guff about “staying close to our customers and clients”. In truth, Barclays’ 3 billion pounds of profit in the first half owes much more to its investment banking division, enlarged by its opportunistic acquisition of Lehman Brothers’ North American business last autumn, than to its traditional banking businesses.

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