Bank regulators are to introduce a globally-consistent leverage ratio as a supplementary measure of individual banks’ soundness.
Judging by some of the complaints the move has triggered, this may seem like a radical shift in banking regulation. In fact, leverage ratios — which limit the total amount a bank can lend relative to its capital base — are not particularly new. U.S. commercial banks have been subject to a 5 percent ratio of capital to total assets for years, and the Swiss imposed a 3 percent ratio on its two big banks at the end of last year.
Christian Noyer, governor of the Bank of France, worries that such a measure might not work: after all, American banks got into trouble just as easily as Europeans. Another concern is that a hard-line backstop for leverage takes no account of the relative riskiness of banks’ assets.
That may be so, but bankers have shown a remarkable ability to manipulate more sophisticated measures. As long as any leverage ratio is used as a diagnostic measure among many other tools within regulators’ toolkit, bankers’ bleatings should be ignored.
The Basel II framework, which has at its heart an equity ratio comparing equity to risk-weighted assets, was meant to encourage banks to lend to safer clients, and to set aside sufficient capital when lending to racier prospects. Unfortunately, regulators largely depended on banks themselves to decide what constituted a safe bet. The result was that, when the crisis hit, banks were woefully undercapitalised.
Another argument is that a leverage ratio makes no distinction between, say, government bonds, AAA-rated asset-backed securities and junk bonds. Given that banks got into trouble by piling on supposedly low-risk AAA bonds backed by U.S. sub-prime mortgages, this would appear to be a good thing. But it could have unintended consequences: Noyer frets that a leverage ratio could add to the reluctance of banks to lend on interbank markets.
Reflecting the impact of different accounting standards may prove more difficult. European banks are required to include the gross value of derivatives contracts on their balance sheets, which makes capital buffers appear smaller. U.S. banks are allowed to report net positions.
Arguably a pure leverage ratio would not allow netting: after all, the crisis showed that even a supposedly solid counterparty like AIG can go under.
Whatever the outcome of this debate, regulators acknowledge that their definition of the leverage ratio must take account of differences in accounting. That is easy to say but tough to do.
The rapid moves towards global convergence of accounting standards were stopped in their tracks by the credit crisis. A series of complex adjustments would undermine the leverage ratio’s simplicity, which is its main appeal, and could open the door for banks to manipulate the figures.
IKB Deutsche Industriebank, the Mittelstand bank that almost collapsed two years ago due to its huge exposure to American sub-prime mortgages, is on the road to recovery.
The bank — now owned by Lone Star, an American private equity firm — on Monday reported first-quarter (April to June) profits of 19.4 million euros against a 517 million euro loss last time.
How are the mighty fallen! Sal Oppenheim may be have been banker to Germany’s elite for 220 years. However, a few rash investments over the past couple of them appear to have forced it into the hands of Deutsche Bank, the 800 pound gorilla of German banking. However, Oppenheim’s clients may be less than delighted at the change of ownership.
The two admitted to being in talks enabling Deutsche to acquire a minority stake on Wednesday, though sources suggest that this could lead to a majority holding.
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
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.
UBS has given investors,depositors and shareholders some nasty surprises in the past
couple of years. However, under a new management team and with the damaging American tax dispute being settled, the bank is positioned for recovery.
True, the scars of recent disasters are still visible. UBS made another big loss of “just” 1.4 billion Swiss francs in the second quarter, albeit less than the deficit of almost 2 billion Swiss francs in the previous one. However, once one-offs — like
a 1.2 billion hit from an improvement in its own credit, a restructuring charge and a goodwill write-down on the sale of its Pactual business in Brazil — are taken into account, the bank turned in a 971 million Swiss franc profit, its best performance in two years.
Both investors and depositors continue to leave in droves, disaffected by UBS’s behaviour. Luxembourg’s financial regulator accused the bank of “serious failure” in its custody of a $1.4 billion fund that invested with fraudster Bernard Madoff, a
charge that UBS strongly rebuts.
U.S.-based customers, many of whom chose UBS because of Switzerland’s famed bank secrecy, have discovered that the bank cannot withstand the twin pressures of an investigation by America’s tax authorities and a political shift against tax havens. UBS’s shares have sharply rallied since news of the settlement emerged last week. However, the details are still being thrashed out between the two governments. The dispute has already damaged UBS’s private bank: the wealth management and
Swiss bank arm saw net outflows of 16.5 billion Swiss francs of client money over the quarter. If UBS does have to hand over thousands of previously confidential names, it may continue to lose clients.
Moreover, any bigger dent in Swiss banking secrecy will impose more collateral damage across the entire Swiss banking industry. This is understood by the Swiss government, which had signalled that punishment of UBS, perhaps in the shape of a
fine, was preferable to allowing foreign tax authorities to go on “fishing expeditions” for tax fugitives.
So far, however, other Swiss banks have avoided the worst of the damage. Julius Baer <BAER.VX>, which reported first half results on July 27, has suffered outflows from GAM, its troubled hedge fund arm, which it is planning to list separately. But it has attracted inflows into its private bank.
Oswald Gruebel, UBS’s newish chief executive, is also making progress in cutting costs and in de-risking the bank. Risk weighted assets fell 11 percent over the quarter, and the bank’s tier 1 capital ratio was 13.7 percent, one of the highest in
Europe. UBS’s leverage ratio is now 3.5 percent, well above the 3 percent minimum stipulated by the Swiss financial regulator.
UBS may never reclaim its reputation as a bastion of banking solidity, but when compared to the depths it has plumbed in the past two years it is on the path to recovery at last.
Standard Chartered may have delivered record profits for the first half of 2009, but the shine has been taken off this by the emerging markets bank’s unexpected 1 billion pound share placing. The shares were trading almost 8 percent lower in the afternoon, at 1323p.
Some discount was to be expected given that the issue was not offered back to existing shareholders. But with StanChart’s market capitalisation of around 27 billion pounds, this should only have lopped around 3.5 percent off the price. The fact that it is almost twice that gives a sense of investors’ disaffection.
StanChart says that it wants the cash “to support the development and growth …in its key strategic markets in Asia, Africa and the Middle East”. It is true that the developing world, particularly Asia, appears to be emerging from this crisis much more robustly than western economies.
Moreover, StanChart can argue that, unlike many periods over the past couple of years, the markets are now open and its shares are trading at more than double their March lows. After all, when it raised 1.8 billion pounds through a rights issue last December – to bolster capital – the new shares were offered at 390p apiece, almost a 50 percent discount to the then price.
StanChart may use the proceeds of the latest proceeds for organic growth. But if the bank is contemplating a specific deal,it does seem odd that it is raising funds ahead of that. After all, the beauty of a placing like this is that it is super-fast. If StanChart trusts its instincts to find a good deal, why not announce deal and share placing simultaneously?
Interestingly, HSBC, StanChart’s big, emerging market rival, is keeping its own hands firmly in its pockets. It is using the $17.8 billion proceedings from its mammoth spring rights issue to bolster capital, with the occasional small deal. In an interview with Reuters in Hong Kong today, Vincent Cheng, the bank’s Asia-Pacific chairman, said that acquisition prospects in Asia were too expensive.
There is an old saying that if you have money it will “burn a hole in your pocket.” This risk is that, once StanChart has collected its 1 billion pound placing proceeds, it may feel compelled to do a deal, whether it is a good one or not.
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.
Britain’s Financial Services Authority has taken a lot of brickbats. its failure to anticipate the crisis is one of the main reasons that George Osborne, the Conservative finance spokesman, now plans to abolish it, transfer most of its supervisory powers (including for insurance) to the Bank of England leaving a rump responsible for consumer protection.
The FSA is in a weak position to defend itself. Even its newish chairman, Lord (Adair) Turner has admitted that it did not foresee the looming problems at Northern Rock, since nationalised. Worse, the regulator was completely ill-equipped to understand the bigger, systemic problems that were looming. Like most other people in and around the markets, it was lulled into a false sense of security.
Shareholder confidence is returning to Sweden’s big four banks, which have reported respectable second quarter earnings over the past week. While SEB <SEBa.ST> and Swedbank <SWEDa.ST> have been harmed by their exposure to the Baltics, overall the four banks have avoided a number of other pitfalls. Both they and the regulators learned lessons from the crisis in the early 1990s.
There are a number of things the Swedes have done well. The banks had strong capital and liquidity ratios going into the crisis. Their lending criteria were strengthened after the earlier crisis-borrowers had to meet strict benchmarks.
Only SEB has (minimal) exposure to US subprime mortgages and only it has any opaque structured credit products, and those are very high quality.
Only SEB and Swedbank have big exposures to the Baltics and, to a lesser extent, Ukraine and Russia. Handelsbanken <SHBa.ST>, which has a local retail banking model, avoided the Balts completely. Nordea <NDA.ST>, which is the successor of Nordbanken, a victim of the 1990s crisis, and in which the Swedish government retains a 20 percent stake, has a tiny exposure to the Balts.
Once this latest crisis emerged, Sweden responded fast by establishing a recapitalisation fund and a liquidity reserve. Paradoxically the recap fund seems to have emboldened private investors to subscribe to rights issues, which they have done in Swedbank, SEB and Nordea. It is much more attractive to invest if you know you are not the only supplier of capital. Only Swedbank has tapped the government for bond funding.
The liquidity fund has helped to keep all the banks, which largely fund themselves in the wholesale markets, (especially SEB and Swedbank), afloat.
Unlike other European countries, which have either avoided stress tests or conducted them in secret, the Swedish financial regulator has conducted strict, public stress tests and published the results on its website, in English, in June.
In a 13-page document, the regulator laid out three scenarios, including one of extreme stress in eastern Europe and a prolonged recession in western Europe. Even under this worst-case scenario, the regulator concluded that all four banks would retain much more than the minimum capital ratio of 4 percent. This transparency has helped restore confidence – bank shares jumped when it was published.
The Riksbank (Sweden’s central bank) further strengthened its position by taking a loan of 3 billion euros from the European Central Bank last month. This is part of its strategy of strengthening its defences against further problems in the Baltics.
Those problems remain. The three Balts are shrinking fast and the threat of devaluation, especially in Latvia, has not disappeared. However, even in that extreme scenario, the danger that this would pull one or more of Sweden’s banks down with it has probably passed.
LONDON, July 20 (Reuters) –Unsurprisingly, it is George Osborne’s proposals to abolish the Financial Services Authority, (FSA) that have grabbed the headlines. However, the centrepiece of the Opposition Conservatives’ financial reform, while intellectually appealing, will prove hellish to implement.
Far more interesting – and surprising, is Osborne’s recognition that Britain cannot “go it alone” on financial reform. Instead, he intends to reverse the Tories’ historic disengagement from Europe and try to lead the debate in Brussels instead.
The central diagnosis – that the tripartite system (FSA, Bank of England and Treasury) of regulation has failed is uncontroversial: an ill-disguised turf war between FSA and the Bank proves the point. Osborne’s proposal to replace it with an enhanced bank and a Consumer Protection Agency (CPA) have intellectual merit. But the devil will be in the details and the Tories have offered precious few of these.
It’s the same story with many of the other proposals. The FSA’s chairman, Adair Turner, the Bank, chancellor Alistair Darling and Osborne all agree that banks should be better capitalised, that they should hold more capital in liquid form, that capital requirements should be countercyclical, and that they should write a “living will” to make them easier to dismantle in a crisis.
However, saying so is the easy step. No one has quite worked out how these measures will be implemented, let alone imposed on a recalcitrant and resurgent banking sector. Osborne too offers few insights on this score.
What is striking is that Osborne has recognised that any major changes will require cross-border negotiation and can’t just be imposed by unilateral fiat (which may be one reason he has dropped his earlier enthusiasm for a separation of retail and investment banking). True, he has thrown the Eurosceptics a bone – “We will fight any new attempt to create an executive pan-European supervisor” – an idea that not even the French have seriously proposed. But he is promising to engage whole-heartedly in Europe, attending the monthly Ecofin finance ministers meetings and deputing one of his junior ministers to Brussels. Moreover the Conservatives will target specific Commission posts so that they can advance the fortunes of the City in Brussels.
Of course, promising to lead the debate is one thing. Actually doing so is another, especially if your party is threatening to reopen the Lisbon treaty and has removed itself from the mainstream centre-right grouping in the European Parliament to join a smaller grouping of Eurosceptic parties.
The Conservatives have been singing from the Brussels songsheet in one area: competition. Osborne has, for instance, talked about dismantling the Lloyds-HBOS merger. But this may just be smart positioning. Brussels will ultimately rule on the conditions to be imposed on banks for receiving state aid. There’s no reason for Osborne to go into bat to defend the Lloyds-HBOS merger, a deal strongly associated in the public mind with Gordon Brown.
However, Osborne isn’t exactly foaming at the mouth to tear down Britain’s banking giants. True, he still intends to ask the UK competition authorities to look at the market structure. But there is no talk of dismantling banks by legislation. That is perhaps understandable. If the Conservatives win the next election, Osborne will find himself as a controlling shareholder in RBS and Lloyds-HBOS. He will have to balance his desire for competition with the desperate need for the taxpayer to recoup its investment in these banks.
The headline attack on the tripartite system is predictable. But the thinking on Europe and competition suggest that behind the radical talk, a more cautious and pragmatic mind is at work.