In your lifetime, you will use plenty of banking products that were previously not available to the ordinary person. Most of us have credit cards, loans, investments and insurances. This has made banking a much more competitive industry, and you have the right to expect great service for your custom.
The face of banking in the UK has changed immeasurably in the past two decades. While we were busy living our lives, the financial services industry consolidated almost overnight, with most small banks being swallowed up by large ones- some fifteen very large global companies take care of the vast majority of daily banking.
But at the same time, lots of exciting new players have appeared. Small banks and lenders provide services for people who otherwise would never have access to credit; or even sometimes a bank account. New technology (cash machines, CHAPS clearance, credit scoring) mean we can get to our money faster- and do more with it.
More of us are investing than ever before- and with government support (remember PEPs and TESSAs, or today’s ISAs) plenty of us are making money out of our savings- even if it’s only a few pennies for a few days.
Banking is now a highly competitive industry whereas twenty years ago, you were grateful that your bank manager even gave you the time of day. Since we are now sophisticated financial consumers, aware of our banking options, and likely to demand several products in our lifetimes (not just a bank account and a mortgage), we owe it to ourselves to force our bank managers to justify their existence. Keep your bank manager on his toes!
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Home Page > Finance > Banking > Best banks for online banking Best banks for online banking Read more: http://www.articlesbase.com/banking-articles/best-banks-for-online-banking-2734213.html#ixzz0sQN88kAm Under Creative Commons License: Attribution
The internet has made many things easier. In fact, it has even made banking easier. It used to be that a person had to send their bill payments by mail, or drive to their bank to take out money. But now, with internet banking, paying a bill or making a transfer to another account is as easy as a click of a button. This article will discuss what to look for in a good online bank.http://www.ixgw.com/ Best Financial Advice - Financial Planning | IXGW.com
What features should you look for
There are a lot of different online banks. When a person is looking for an online bank that they would like to use, there are a few features that they should look for in the online bank that would make some a better choice than others.
Fees
A person should look for an online bank that does not have fees. The majority of online bill pay accounts are free or at least a limited amount of free bill pay. Some online banks charge a fee if the account balance falls below a certain amount or if there is a certain amount of time of inactivity. People looking to do online banking should be aware of the fees that may be attached to certain services and look for online banks that do not have very many or any fees.
User-friendly website
An online bank should have a very user friendly internet site. Since the majority of the activity for the account(s) will be done using the website it should be easy to navigate, have the features that a person needs to do online banking, and it should be easy to learn how to use the actual site. The online banking website should include things such as the history of the account and transaction reports, and information that will help warn people of possible security threats. People should look for a bank that offers their cancelled check images. If someone has forgotten who the payee is for a certain check number, these images can be helpful.
Transfers
A person should make sure that their online bank lets them make transfers to their other accounts online. Some banks even let their member make payments on loans through the same bank by just transferring money or let a person set up automatic deductions from their account to make payments.
Reminders and email alerts
Some online banks send email alerts and/or reminders. This can be helpful for someone who is interested in being notified when there is a lot of activity on a credit card or if someone is trying to get into the account using an incorrect password. Some reminders or email alerts are for things as simple as if the person is getting low on checks.
Spending Report
Having a spending report on the website of a person's online bank can be helpful for them so that they can more easily budget what they spend on groceries, entertainment, and other bills. It can be helpful for people to see how they spend their money each week and month.
Security
It is important that the online banking is secure with security updates and the opportunity for a person to change their password often.
What are some of the best online banks
Some of the best online banks include: Wellsfargo.com, Citibank.com, Bankofamerica.com, Bankus.etrade.com, Huntington.com, Chase.com, Usbank.com, Hsbc.com, and Firstnational.com. All of these online banks have some similar features as well as some different features. A person looking for an online bank should take time to research a few online banks to see if it contains the features that will work best for what they are interested in using for their online bank. Some local banks offer online services as well. People should look into banks that are located in their home city and see if their online services will work for them.
Read more: http://www.articlesbase.com/banking-articles/best-banks-for-online-banking-2734213.html#ixzz0sQMyC5XN
Under Creative Commons License: Attribution
What features should you look for
There are a lot of different online banks. When a person is looking for an online bank that they would like to use, there are a few features that they should look for in the online bank that would make some a better choice than others.
Fees
A person should look for an online bank that does not have fees. The majority of online bill pay accounts are free or at least a limited amount of free bill pay. Some online banks charge a fee if the account balance falls below a certain amount or if there is a certain amount of time of inactivity. People looking to do online banking should be aware of the fees that may be attached to certain services and look for online banks that do not have very many or any fees.
User-friendly website
An online bank should have a very user friendly internet site. Since the majority of the activity for the account(s) will be done using the website it should be easy to navigate, have the features that a person needs to do online banking, and it should be easy to learn how to use the actual site. The online banking website should include things such as the history of the account and transaction reports, and information that will help warn people of possible security threats. People should look for a bank that offers their cancelled check images. If someone has forgotten who the payee is for a certain check number, these images can be helpful.
Transfers
A person should make sure that their online bank lets them make transfers to their other accounts online. Some banks even let their member make payments on loans through the same bank by just transferring money or let a person set up automatic deductions from their account to make payments.
Reminders and email alerts
Some online banks send email alerts and/or reminders. This can be helpful for someone who is interested in being notified when there is a lot of activity on a credit card or if someone is trying to get into the account using an incorrect password. Some reminders or email alerts are for things as simple as if the person is getting low on checks.
Spending Report
Having a spending report on the website of a person's online bank can be helpful for them so that they can more easily budget what they spend on groceries, entertainment, and other bills. It can be helpful for people to see how they spend their money each week and month.
Security
It is important that the online banking is secure with security updates and the opportunity for a person to change their password often.
What are some of the best online banks
Some of the best online banks include: Wellsfargo.com, Citibank.com, Bankofamerica.com, Bankus.etrade.com, Huntington.com, Chase.com, Usbank.com, Hsbc.com, and Firstnational.com. All of these online banks have some similar features as well as some different features. A person looking for an online bank should take time to research a few online banks to see if it contains the features that will work best for what they are interested in using for their online bank. Some local banks offer online services as well. People should look into banks that are located in their home city and see if their online services will work for them.
Read more: http://www.articlesbase.com/banking-articles/best-banks-for-online-banking-2734213.html#ixzz0sQMyC5XN
Under Creative Commons License: Attribution
Sunday, June 6, 2010
Good Banks, Bad Banks, and Government's Role as Fixer Published: December 21, 2009 Author: Roger Thompson
Most books about the nation's financial crisis tell us what happened. In his new book, HBS senior lecturer Robert Pozen tells us how to fix the system. A financial industry veteran and chairman of MFS Investment Management, a Boston firm that oversees more than $170 billion in pension and mutual funds, Pozen writes with authority and unusual clarity about complex issues in Too Big to Save? How to Fix the U.S. Financial System (John Wiley & Sons).
Roger Thompson: How does the government figure out which financial institutions are too big to fail?
Robert Pozen: There are two valid reasons for bailing out a financial institution. First is to protect the system for processing payments, like checks, because that system is critical to the operation of the U.S. economy. Second is to avoid a situation where the failure of one large, interconnected financial institution is likely to lead to the failure of many other large institutions.
Most of the 600 institutions recapitalized by the federal government over the last year do not satisfy either criterion. A lot of bailout decisions were made ad hoc without a clear rationale. For instance, the government bailed out Bear Stearns, but why not Lehman Brothers? Ironically, Congress in 1991 passed a statute establishing specific procedures (including stating a rationale) to be followed before a bank could be rescued and mandating an after-the-fact audit by the Comptroller General. But because Bear and AIG weren't banks, no one had to explain what they were doing under the 1991 statute. To hold senior government officials accountable for all bailouts, Congress should extend the 1991 statute to any type of financial institution.
Q: How has Congress tried to restore confidence in credit rating agencies?
A: The first thing Congress did in 2006 was to boost competition. We now have nine approved rating agencies instead of three. However, if you are a bond issuer and you don't like what one rating agency says, you can choose another. So now, you have tripled the number of choices. That doesn't solve the problem of forum shopping. In fact, it makes it worse.
Q: What if rating agencies were paid by investors rather than by bond issuers? Wouldn't that stop forum shopping?
A: In theory, yes. The people who are being served by the rating agencies, the investors, should pay for the service. But that's not going to happen because the largest investors in bonds—banks, insurance companies, and mutual funds—aren't willing to pay because they think they do a much better job than the rating agencies.
What I propose is a neutral third-party approach to ratings. The SEC would designate a knowledgeable person, independent of both issuers and rating agencies, to select a rating agency for the bond issuer and negotiate a rating fee. This would eliminate the two worst abuses: the issuer shopping for a higher rating, and the issuer paying inflated fees to get a higher rating. But the issuer would still pay for the fees of the rating agency after it was selected by the third party.
Q: You note in your book that loan securitization collapsed at the end of 2008. Has it revived yet, and why is it important for a healthy economy?
A: The monthly volume of securitization in 2007 was over $100 billion. Now, it's $1 or $2 billion a month. So we've got a long way to go. And we need to get securitization going because that's what drives loan volume.
Q: Why has loan securitization been slow to recover?
A: We had a terrible system of securitization where everything was off balance sheet, and we made believe that the sponsors, the biggest money center banks, had zero risk of loss. They did not fully disclose what was happening, and they did not put up enough capital to cover potential risks. Now, the FASB [Financial Accounting Standards Board] has overacted by adopting rules that effectively force all securitizations on the balance sheet. Since the new rules treat banks as if they have 100 percent of the risk of loss, they must put up capital as if that were true.
So we've gone from one extreme to another, with the reality lying somewhere in between. If we are going to resuscitate securitization, we should utilize off-balance-sheet entities but with a transparent process and capital charges that are based on actual risks. We want banks to disclose their potential liabilities to these entities and to put capital behind these risks. Unless we have that sort of transparent process backed by capital, we're not going to revive securitization.
Q: Corporate boards have been criticized for being asleep at the wheel leading up to last year's financial meltdown. Are boards at fault?
A: After Enron and WorldCom, Congress hastily passed Sarbanes-Oxley, basically a very elaborate set of procedures for boards to follow. But it's very clear that the boards of megabanks—the nineteen banks with over $100 billion in assets—complied with Sarbanes-Oxley and somehow didn't realize what huge risks they were taking.
Q: If boards don't need more procedures, what do they need?
A: Some of the most effective boards are those at companies that are owned by private equity. They are composed of the CEO and six directors, all of whom have relevant industry expertise. The directors make the time commitment, spending several days each month at the company. And they all have significant stock incentives.
The question is, what can we learn from the private equity model? When it comes to megabanks, I'm in favor of a smaller board with deep financial expertise, substantial time commitments, and a different pay structure. We can try to be clever and add more procedures. But unless we rethink the board model in a very fundamental way, I believe we're kidding ourselves. Is it likely that somebody who isn't a financial expert can show up six times a year and really understand Citigroup?
Q: In an attempt to head off the next financial crisis, should Congress designate a systemic risk regulator? If so, who should that be?
A: The Treasury has proposed that systemic risks be monitored by a newly formed Financial Services Oversight Council, with the Fed becoming the primary regulator of all institutions posing such risks. I disagree with making the Fed the primary risk regulator.
First of all, the notion that the Fed could be the primary regulator of every systemically risky institution is just not practical. That means it would need to be an expert on money market funds, hedge funds, and life insurance companies as well as banks. Second, if you identify an institution as systemically risky, you're creating moral hazard [implicit federal guarantees] by that very process. Third, you're assuming that we can know in advance every institution that's systemically risky, but I don't think that's possible. Finally, why do we assume that it's just institutions? Sometimes rapidly growing new financial products are systemically risky, like credit default swaps.
Q: What would you do?
A: My proposal is just the opposite of the Treasury's. I would put the Fed in charge of risk monitoring because that's where it has the most expertise. When the Fed comes upon a systemic risk, it should turn to the relevant regulatory agency to resolve the problem. So you get the best of both worlds. The Fed does what it's best at, macro risk monitoring. And the agencies with the deepest expertise in the relevant financial area would be in charge of problem resolution. Moreover, if the Fed assumed the role as primary regulator of all systemically risky institutions, it would jeopardize its political independence. And that would be a big mistake.
Excerpt: The New Structure of U.S. Financial Regulation
by Robert Pozen, from Too Big To Save
To provide taxpayers with an equitable stake in a mega bank that needs exceptional assistance, the Treasury should contribute capital by purchasing common shares. As a result, the Treasury is likely to hold a majority ownership of the bank's common shares, while the ownership interests of other shareholders will be reduced. This is not permanent nationalization in the socialism sense; this is temporary majority ownership by the government until it can dispose of the mega bank. By owning a majority of the troubled mega bank's shares, the Treasury can enjoy most of the bank's upside gains as well as absorbing most of its downside losses.
With majority ownership of seriously troubled banks by the federal government, it can divide them into good banks and bad banks. The good banks would return to the normal business of taking deposits and making loans; the bad banks would work out and sell toxic assets over several years. If the U.S. Treasury and other existing securities holders were given equal ownership interest in both banks, taxpayers would participate in the potential upside as well as shoulder losses. Moreover, splitting a trouble institution in this manner would avoid the intractable problem of setting a fair price now for the sale of its toxic assets.
The splitting of a troubled institution into two banks is a much better approach than the creation of heavily subsidized public-private partnerships to try to buy toxic assets. These partnerships are another example of one-way capitalism: Private investors receive 50 percent of the upside but little of the downside on toxic assets that are actually purchased. Moreover, the partnerships are likely not to set a market price on many toxic assets, because the government will not provide generous subsidies to buy them on a regular basis.
The government's focus on recapitalizing banks and buying their toxic assets seems to be based on the assumption that banks are the primary originator of new loans. In fact, banks accounted for only 22 percent of the credit extended in the United States. The main cause of reduced lending has been the collapse of the loan securitization process, which allows banks and nonbanks to sell loans and re-lend the cash proceeds multiple times. The volume of new issues of securitized loans has fallen off a cliff, from $100 billion a month in 2006 to almost zero at the end of 2008.
To revive the process of securitizing loans, the United States needs to establish proper incentives at each stage of the process. We need to ensure that mortgages are appropriate for the resources of borrowers, and that mortgage brokers have skin in the game when they sell loans. We need to control the conflicts of interest of credit-rating agencies and reformulate the capital requirements for bank sponsors of special purpose entities (SPEs) that issue asset-backed securities. But all asset securitization should not be forced back on the balance sheets of banks. Instead, bank sponsors should publicly disclose and back with capital their continuing or contingent obligations to any SPE they sponsor.
In response to the financial crisis, the federal government has substantially increased its intervention into the financial markets. Although such intervention is justified in certain cases, federal guarantees of debt offering are too extensive. To avoid moral hazard, the FDIC should guarantee 90 percent, rather than 100 percent, of debt offerings by banks and thrifts. Further, Congress should not extend beyond 2013 the higher limits on FDIC deposit insurance. The previous limits covered 98 percent of all depositors. The United States should move away from a financial sector with broad-based government guarantees to one with market discipline exerted by sophisticated and at-risk investors in bank debt.
The federal government should not be encouraging mergers among large institutions in the financial sector, which is now dominated by a handful of mega banks. The Justice Department should reject mergers that are likely to create more mega banks that are too big to fail. However, we should not attempt to increase competition in the financial sector by reinstating the barriers of the Glass-Steagall Act to the securities activities of banks. Freestanding investment banks present systemic risks because they have limited sources of short-term liquidity: commercial paper and repurchase agreements. Banks with securities powers can also obtain short-term financing through Fed loans and retail deposits.
Given the decline in investor discipline and market competitions, the monitoring of financial institutions has been left mainly to federal regulators. But there are limits to the effectiveness of any federal regulator in light of the fast pace of financial innovation and complexity of financial transactions. On a regular basis, the outside directors of a mega bank should be responsible for monitoring its activities. However, most outside directors of mega banks are not financial experts, do not spend enough time on board matters, and do not have a large equity stake in these institutions. If the United States wants effective board oversight of complex financial institutions, we should move to the private equity model for their boards. Under that model, a small group of super-directors with extensive financial expertise would spend several days every month at the bank; they would also have substantial holdings of the bank's stock.
A board of super-directors would be well-placed to monitor the financial condition of a mega bank and set the compensation of its senior executives in order to attain its dual goals of maximizing long-term profits for its shareholders without taking risks that would materially jeopardize the bank's solvency. Thus, super-directors are critical to fixing the U.S. financial system and moving it to accountable capitalism
Roger Thompson: How does the government figure out which financial institutions are too big to fail?
Robert Pozen: There are two valid reasons for bailing out a financial institution. First is to protect the system for processing payments, like checks, because that system is critical to the operation of the U.S. economy. Second is to avoid a situation where the failure of one large, interconnected financial institution is likely to lead to the failure of many other large institutions.
Most of the 600 institutions recapitalized by the federal government over the last year do not satisfy either criterion. A lot of bailout decisions were made ad hoc without a clear rationale. For instance, the government bailed out Bear Stearns, but why not Lehman Brothers? Ironically, Congress in 1991 passed a statute establishing specific procedures (including stating a rationale) to be followed before a bank could be rescued and mandating an after-the-fact audit by the Comptroller General. But because Bear and AIG weren't banks, no one had to explain what they were doing under the 1991 statute. To hold senior government officials accountable for all bailouts, Congress should extend the 1991 statute to any type of financial institution.
Q: How has Congress tried to restore confidence in credit rating agencies?
A: The first thing Congress did in 2006 was to boost competition. We now have nine approved rating agencies instead of three. However, if you are a bond issuer and you don't like what one rating agency says, you can choose another. So now, you have tripled the number of choices. That doesn't solve the problem of forum shopping. In fact, it makes it worse.
Q: What if rating agencies were paid by investors rather than by bond issuers? Wouldn't that stop forum shopping?
A: In theory, yes. The people who are being served by the rating agencies, the investors, should pay for the service. But that's not going to happen because the largest investors in bonds—banks, insurance companies, and mutual funds—aren't willing to pay because they think they do a much better job than the rating agencies.
What I propose is a neutral third-party approach to ratings. The SEC would designate a knowledgeable person, independent of both issuers and rating agencies, to select a rating agency for the bond issuer and negotiate a rating fee. This would eliminate the two worst abuses: the issuer shopping for a higher rating, and the issuer paying inflated fees to get a higher rating. But the issuer would still pay for the fees of the rating agency after it was selected by the third party.
Q: You note in your book that loan securitization collapsed at the end of 2008. Has it revived yet, and why is it important for a healthy economy?
A: The monthly volume of securitization in 2007 was over $100 billion. Now, it's $1 or $2 billion a month. So we've got a long way to go. And we need to get securitization going because that's what drives loan volume.
Q: Why has loan securitization been slow to recover?
A: We had a terrible system of securitization where everything was off balance sheet, and we made believe that the sponsors, the biggest money center banks, had zero risk of loss. They did not fully disclose what was happening, and they did not put up enough capital to cover potential risks. Now, the FASB [Financial Accounting Standards Board] has overacted by adopting rules that effectively force all securitizations on the balance sheet. Since the new rules treat banks as if they have 100 percent of the risk of loss, they must put up capital as if that were true.
So we've gone from one extreme to another, with the reality lying somewhere in between. If we are going to resuscitate securitization, we should utilize off-balance-sheet entities but with a transparent process and capital charges that are based on actual risks. We want banks to disclose their potential liabilities to these entities and to put capital behind these risks. Unless we have that sort of transparent process backed by capital, we're not going to revive securitization.
Q: Corporate boards have been criticized for being asleep at the wheel leading up to last year's financial meltdown. Are boards at fault?
A: After Enron and WorldCom, Congress hastily passed Sarbanes-Oxley, basically a very elaborate set of procedures for boards to follow. But it's very clear that the boards of megabanks—the nineteen banks with over $100 billion in assets—complied with Sarbanes-Oxley and somehow didn't realize what huge risks they were taking.
Q: If boards don't need more procedures, what do they need?
A: Some of the most effective boards are those at companies that are owned by private equity. They are composed of the CEO and six directors, all of whom have relevant industry expertise. The directors make the time commitment, spending several days each month at the company. And they all have significant stock incentives.
The question is, what can we learn from the private equity model? When it comes to megabanks, I'm in favor of a smaller board with deep financial expertise, substantial time commitments, and a different pay structure. We can try to be clever and add more procedures. But unless we rethink the board model in a very fundamental way, I believe we're kidding ourselves. Is it likely that somebody who isn't a financial expert can show up six times a year and really understand Citigroup?
Q: In an attempt to head off the next financial crisis, should Congress designate a systemic risk regulator? If so, who should that be?
A: The Treasury has proposed that systemic risks be monitored by a newly formed Financial Services Oversight Council, with the Fed becoming the primary regulator of all institutions posing such risks. I disagree with making the Fed the primary risk regulator.
First of all, the notion that the Fed could be the primary regulator of every systemically risky institution is just not practical. That means it would need to be an expert on money market funds, hedge funds, and life insurance companies as well as banks. Second, if you identify an institution as systemically risky, you're creating moral hazard [implicit federal guarantees] by that very process. Third, you're assuming that we can know in advance every institution that's systemically risky, but I don't think that's possible. Finally, why do we assume that it's just institutions? Sometimes rapidly growing new financial products are systemically risky, like credit default swaps.
Q: What would you do?
A: My proposal is just the opposite of the Treasury's. I would put the Fed in charge of risk monitoring because that's where it has the most expertise. When the Fed comes upon a systemic risk, it should turn to the relevant regulatory agency to resolve the problem. So you get the best of both worlds. The Fed does what it's best at, macro risk monitoring. And the agencies with the deepest expertise in the relevant financial area would be in charge of problem resolution. Moreover, if the Fed assumed the role as primary regulator of all systemically risky institutions, it would jeopardize its political independence. And that would be a big mistake.
Excerpt: The New Structure of U.S. Financial Regulation
by Robert Pozen, from Too Big To Save
To provide taxpayers with an equitable stake in a mega bank that needs exceptional assistance, the Treasury should contribute capital by purchasing common shares. As a result, the Treasury is likely to hold a majority ownership of the bank's common shares, while the ownership interests of other shareholders will be reduced. This is not permanent nationalization in the socialism sense; this is temporary majority ownership by the government until it can dispose of the mega bank. By owning a majority of the troubled mega bank's shares, the Treasury can enjoy most of the bank's upside gains as well as absorbing most of its downside losses.
With majority ownership of seriously troubled banks by the federal government, it can divide them into good banks and bad banks. The good banks would return to the normal business of taking deposits and making loans; the bad banks would work out and sell toxic assets over several years. If the U.S. Treasury and other existing securities holders were given equal ownership interest in both banks, taxpayers would participate in the potential upside as well as shoulder losses. Moreover, splitting a trouble institution in this manner would avoid the intractable problem of setting a fair price now for the sale of its toxic assets.
The splitting of a troubled institution into two banks is a much better approach than the creation of heavily subsidized public-private partnerships to try to buy toxic assets. These partnerships are another example of one-way capitalism: Private investors receive 50 percent of the upside but little of the downside on toxic assets that are actually purchased. Moreover, the partnerships are likely not to set a market price on many toxic assets, because the government will not provide generous subsidies to buy them on a regular basis.
The government's focus on recapitalizing banks and buying their toxic assets seems to be based on the assumption that banks are the primary originator of new loans. In fact, banks accounted for only 22 percent of the credit extended in the United States. The main cause of reduced lending has been the collapse of the loan securitization process, which allows banks and nonbanks to sell loans and re-lend the cash proceeds multiple times. The volume of new issues of securitized loans has fallen off a cliff, from $100 billion a month in 2006 to almost zero at the end of 2008.
To revive the process of securitizing loans, the United States needs to establish proper incentives at each stage of the process. We need to ensure that mortgages are appropriate for the resources of borrowers, and that mortgage brokers have skin in the game when they sell loans. We need to control the conflicts of interest of credit-rating agencies and reformulate the capital requirements for bank sponsors of special purpose entities (SPEs) that issue asset-backed securities. But all asset securitization should not be forced back on the balance sheets of banks. Instead, bank sponsors should publicly disclose and back with capital their continuing or contingent obligations to any SPE they sponsor.
In response to the financial crisis, the federal government has substantially increased its intervention into the financial markets. Although such intervention is justified in certain cases, federal guarantees of debt offering are too extensive. To avoid moral hazard, the FDIC should guarantee 90 percent, rather than 100 percent, of debt offerings by banks and thrifts. Further, Congress should not extend beyond 2013 the higher limits on FDIC deposit insurance. The previous limits covered 98 percent of all depositors. The United States should move away from a financial sector with broad-based government guarantees to one with market discipline exerted by sophisticated and at-risk investors in bank debt.
The federal government should not be encouraging mergers among large institutions in the financial sector, which is now dominated by a handful of mega banks. The Justice Department should reject mergers that are likely to create more mega banks that are too big to fail. However, we should not attempt to increase competition in the financial sector by reinstating the barriers of the Glass-Steagall Act to the securities activities of banks. Freestanding investment banks present systemic risks because they have limited sources of short-term liquidity: commercial paper and repurchase agreements. Banks with securities powers can also obtain short-term financing through Fed loans and retail deposits.
Given the decline in investor discipline and market competitions, the monitoring of financial institutions has been left mainly to federal regulators. But there are limits to the effectiveness of any federal regulator in light of the fast pace of financial innovation and complexity of financial transactions. On a regular basis, the outside directors of a mega bank should be responsible for monitoring its activities. However, most outside directors of mega banks are not financial experts, do not spend enough time on board matters, and do not have a large equity stake in these institutions. If the United States wants effective board oversight of complex financial institutions, we should move to the private equity model for their boards. Under that model, a small group of super-directors with extensive financial expertise would spend several days every month at the bank; they would also have substantial holdings of the bank's stock.
A board of super-directors would be well-placed to monitor the financial condition of a mega bank and set the compensation of its senior executives in order to attain its dual goals of maximizing long-term profits for its shareholders without taking risks that would materially jeopardize the bank's solvency. Thus, super-directors are critical to fixing the U.S. financial system and moving it to accountable capitalism
Monday, April 12, 2010
Shine a light
The parallel “shadow” banking system needs fixing: that should mean painful choices for money-market funds
Mar 25th 2010 | From The Economist print edition
IF THEY were to film “It’s a Wonderful Life” today, the hero would probably not be a banker—and not just because of the optimistic title. The shape of finance has changed radically in the past few decades. For every traditional bank clerk there are several sorts of financial intermediators. The character of George Bailey would today be as likely to manage a money-market fund as take in humble bank deposits. Or he might work at Fannie Mae and Freddie Mac, America’s housing-finance giants, buying home loans from banks and packaging them into mortgage-backed securities.
This “shadow” banking system is huge, particularly in America—too big for the banks to be able to replace it. In the summer of 2007 assets funded through the capital markets were larger than those held by America’s banks. Only one-third of the country’s home mortgages were on banks’ balance-sheets. The bank bail-outs hog attention, but many of the government’s crisis measures were designed to prop up the shadow system. Even so, many bits of it, especially private mortgage-backed securities, remain moribund (see article).
That is a bad thing. The intellectual case for securitisation, the process of pooling lots of different loans and selling the cashflows to investors, remains strong. Done properly, it should enable banks and investors to diversify their exposures. In Europe, where bank lending is more important, it offers a useful, alternative source of financing. But the shadow system has to become far more stable. Great chunks of the crisis happened outside the banks. The rot started in the market for securitised subprime mortgages. Bear Stearns and Lehman Brothers were non-banks that were crippled by a silent run among panicky overnight “repo” lenders, many of them money-market funds uncertain about the quality of securitised collateral they were holding. Mass redemptions from these funds after Lehman’s failure froze short-term funding for big firms.
Towards a penumbral banking system
So far the reformers of finance have neglected the shadow system. Some changes are on the way—new liquidity rules for money-market funds, for instance. But uncertainty about the long-term prospects of Fannie and Freddie has been a brake on the revival of securitisation. Congress started hearings on their future this week, but the White House has yet to put forward detailed thoughts of its own. Fiddlier issues require more clarity, too. Investors want assurance that securitised assets will be ring-fenced from claims if a lender fails, for instance.
Real World Banking and Finance: A Dollars & Sense Reader, 5th Edition
So more attention is needed. But what should be done? Two things stand out. The first is the need to project some light into the shadows. The pre-crisis securitisation markets were deeply murky. Efforts to get banks to retain more of the risk associated with securitised loans are well-intentioned, but the danger is that investors will regard this as a comfort blanket (as they previously saw gold-plated credit ratings) and skimp on due diligence. Investors need to have up-to-date information on the quality of the loans inside securities: central banks can help by mandating disclosure requirements for collateral that they accept at the discount window. And regulators need better data on obscure areas like triparty repo and stock lending.
The other imperative is to make sure that the bits of the shadow system that act just like banks are regulated accordingly. That shift in thinking has already happened for investment banks, but needs to go further. Money-market funds are an obvious example. Investors in these funds expect to get their money back on demand, just like depositors in a bank. The post-Lehman run started after one fund “broke the buck”; it stopped when the government said it would guarantee investors against losses. So these funds should be forced to make a choice: keep the commitment to pay up and set aside capital and insurance funds (like banks have to do); or drop the commitment and put the burden of losses on investors.
Mar 25th 2010 | From The Economist print edition
IF THEY were to film “It’s a Wonderful Life” today, the hero would probably not be a banker—and not just because of the optimistic title. The shape of finance has changed radically in the past few decades. For every traditional bank clerk there are several sorts of financial intermediators. The character of George Bailey would today be as likely to manage a money-market fund as take in humble bank deposits. Or he might work at Fannie Mae and Freddie Mac, America’s housing-finance giants, buying home loans from banks and packaging them into mortgage-backed securities.
This “shadow” banking system is huge, particularly in America—too big for the banks to be able to replace it. In the summer of 2007 assets funded through the capital markets were larger than those held by America’s banks. Only one-third of the country’s home mortgages were on banks’ balance-sheets. The bank bail-outs hog attention, but many of the government’s crisis measures were designed to prop up the shadow system. Even so, many bits of it, especially private mortgage-backed securities, remain moribund (see article).
That is a bad thing. The intellectual case for securitisation, the process of pooling lots of different loans and selling the cashflows to investors, remains strong. Done properly, it should enable banks and investors to diversify their exposures. In Europe, where bank lending is more important, it offers a useful, alternative source of financing. But the shadow system has to become far more stable. Great chunks of the crisis happened outside the banks. The rot started in the market for securitised subprime mortgages. Bear Stearns and Lehman Brothers were non-banks that were crippled by a silent run among panicky overnight “repo” lenders, many of them money-market funds uncertain about the quality of securitised collateral they were holding. Mass redemptions from these funds after Lehman’s failure froze short-term funding for big firms.
Towards a penumbral banking system
So far the reformers of finance have neglected the shadow system. Some changes are on the way—new liquidity rules for money-market funds, for instance. But uncertainty about the long-term prospects of Fannie and Freddie has been a brake on the revival of securitisation. Congress started hearings on their future this week, but the White House has yet to put forward detailed thoughts of its own. Fiddlier issues require more clarity, too. Investors want assurance that securitised assets will be ring-fenced from claims if a lender fails, for instance.
Real World Banking and Finance: A Dollars & Sense Reader, 5th Edition
So more attention is needed. But what should be done? Two things stand out. The first is the need to project some light into the shadows. The pre-crisis securitisation markets were deeply murky. Efforts to get banks to retain more of the risk associated with securitised loans are well-intentioned, but the danger is that investors will regard this as a comfort blanket (as they previously saw gold-plated credit ratings) and skimp on due diligence. Investors need to have up-to-date information on the quality of the loans inside securities: central banks can help by mandating disclosure requirements for collateral that they accept at the discount window. And regulators need better data on obscure areas like triparty repo and stock lending.
The other imperative is to make sure that the bits of the shadow system that act just like banks are regulated accordingly. That shift in thinking has already happened for investment banks, but needs to go further. Money-market funds are an obvious example. Investors in these funds expect to get their money back on demand, just like depositors in a bank. The post-Lehman run started after one fund “broke the buck”; it stopped when the government said it would guarantee investors against losses. So these funds should be forced to make a choice: keep the commitment to pay up and set aside capital and insurance funds (like banks have to do); or drop the commitment and put the burden of losses on investors.
Tuesday, March 16, 2010
Ponemon Institute/Guardian Analytics study finds 40 percent of small and medium businesses change banks after a fraud incident.
Everyone knows business online banking fraud has increased over the past few years, with new incidents reported every day. But a study released by the Ponemon Institute and Guardian Analytics yesterday quantifies just how large and pervasive this problem has become.
According to the research, which polled 500 executives and business owners from small and medium businesses in the United States, 55 percent of businesses were victims of fraud in the last 12 months, with 58 percent of fraud enabled by online banking activities. Eighty percent of banks failed to catch fraud before funds were transferred out of their institution. In 87 percent of fraud attacks, the bank was unable to fully recover assets and 57 percent of the respondents that experienced a fraud attack were not fully compensated by their banks. Twenty-six percent were not compensated for any part of their losses.
Related ResourcesCredit Risk Management: Challenges and Opportunities in Turbulent Times After the Storm: A new era for risk management in financial services Authentication and Fraud Detection Buyer’s Guide from Entrust All this fraud has damaged banks' business customer relationships — 40 percent of businesses said they have moved their banking activities elsewhere after a fraud incident. Eleven percent of businesses that have experienced fraud claimed they have terminated their banking relationship following fraud attacks, and additional 29 percent said they did not fully terminate their relationship, but moved their primary cash management services to another institution.
Business customers surveyed complained of a lack of transparency; 24 percent of businesses claim that their banks do not provide a policy explaining the bank's responsibilities to secure and protect their companies' accounts from fraud. Thirty-nine percent are unsure if such a policy exists.
"Banks have a new troubled asset — their customers," said Terry Austin, CEO, Guardian Analytics, in a statement. "The survey data proves that financial institutions are failing to protect the small and medium businesses that are at the heart of our economic recovery. SMBs are fed up with the banks that are leaving them vulnerable to fraud and not reimbursing them when they are attacked. Banks that do not improve their fraud prevention practices will lose customers and hurt their own recovery."
"Ultimately the data points to the need for banks to evolve their definition of reasonable security and proactively invest in process and technology to better protect their online banking customers," said Dr. Larry Ponemon, chairman and founder, Ponemon Institute. "Only 20 percent of banks were able to identify fraud before money was transferred. The ROI of investing in fraud prevention is clear when you consider how fraud and churn drive productivity and profit loss as well as legal and reputation risks."
According to the research, which polled 500 executives and business owners from small and medium businesses in the United States, 55 percent of businesses were victims of fraud in the last 12 months, with 58 percent of fraud enabled by online banking activities. Eighty percent of banks failed to catch fraud before funds were transferred out of their institution. In 87 percent of fraud attacks, the bank was unable to fully recover assets and 57 percent of the respondents that experienced a fraud attack were not fully compensated by their banks. Twenty-six percent were not compensated for any part of their losses.
Related ResourcesCredit Risk Management: Challenges and Opportunities in Turbulent Times After the Storm: A new era for risk management in financial services Authentication and Fraud Detection Buyer’s Guide from Entrust All this fraud has damaged banks' business customer relationships — 40 percent of businesses said they have moved their banking activities elsewhere after a fraud incident. Eleven percent of businesses that have experienced fraud claimed they have terminated their banking relationship following fraud attacks, and additional 29 percent said they did not fully terminate their relationship, but moved their primary cash management services to another institution.
Business customers surveyed complained of a lack of transparency; 24 percent of businesses claim that their banks do not provide a policy explaining the bank's responsibilities to secure and protect their companies' accounts from fraud. Thirty-nine percent are unsure if such a policy exists.
"Banks have a new troubled asset — their customers," said Terry Austin, CEO, Guardian Analytics, in a statement. "The survey data proves that financial institutions are failing to protect the small and medium businesses that are at the heart of our economic recovery. SMBs are fed up with the banks that are leaving them vulnerable to fraud and not reimbursing them when they are attacked. Banks that do not improve their fraud prevention practices will lose customers and hurt their own recovery."
"Ultimately the data points to the need for banks to evolve their definition of reasonable security and proactively invest in process and technology to better protect their online banking customers," said Dr. Larry Ponemon, chairman and founder, Ponemon Institute. "Only 20 percent of banks were able to identify fraud before money was transferred. The ROI of investing in fraud prevention is clear when you consider how fraud and churn drive productivity and profit loss as well as legal and reputation risks."
Friday, February 5, 2010
Regulators are trying to make banks better equipped against catastrophe
THE world’s banking system is both mindbogglingly complex and too vital to fail. After only a year’s deliberation, the finest minds in governments, regulatory bodies and central banks have decided how to improve the way it is supervised. Their answer, it appears, is thicker insulation and better preparation against folly and accident. In December, under instruction from the G20, the Basel club of bank supervisors published new proposals on capital and liquidity “buffers”. These could be in force by the end of 2012.
The speed of the reaction is impressive and most of the proposals look sensible. Yet a feeling remains that the fine minds have evaded the really difficult question. If the banking system resembles a line of climbers roped together, then regulators are busy making the clothes warmer, the maps more accurate, the rations more filling and the whistles louder. Unfortunately none of that is any good if someone falls over the edge, as a handful of banks are wont to do in financial crises. Unless a way is found to solve this problem, taxpayers will remain destined to rescue the flakiest firms time and time again.
In part the focus on capital and liquidity buffers reflects the poverty of the alternatives. Breaking up banks is hard and of uncertain benefit. Having public-sector bureaucrats run them is as unattractive as leaving the discredited masters of the universe in charge. And despite promises that regulators will be cleverer and central bankers more alert, banks are certain to get into trouble again, as they always have. The way to protect taxpayers, the argument goes, is to compel banks to have buffers thick enough to withstand higher losses and longer freezes in financial markets before they call for state help.
The proposals have already been dubbed “Basel 3”—which tells you regulators have been here twice before. Alas, the record of bank-capital rules is crushingly bad. The Basel regime (European and American banks use either version 1 or 2) represents a monumental, decades-long effort at perfection, with minimum capital requirements carefully calculated from detailed formulae. The answers were precisely wrong. Five days before its bankruptcy Lehman Brothers boasted a “Tier 1” capital ratio of 11%, almost three times the regulatory minimum.
That poses an obvious question for bank supervisors: if they have already tried and failed to make capital rules foolproof, why should they do better this time? They do not just have to worry about rules being too slack. If they overreact to the financial crisis and devise rules that are too strict, they may endanger the recovery. And how can supervisors deal with the basket-case banks, for which no reasonable buffer will be adequate?
In the days when banks (and their customers) could not rely on governments to save them, they carried huge buffers to protect themselves against losses and drops in confidence. In the late 19th century a typical American or British bank had an equity buffer—ie, core capital—equivalent to 15-25% of its assets (see chart 1). As recently as the 1960s British banks held more than a quarter of their assets in low-risk, liquid form, such as cash or government bonds.
Over time governments have supplied more protection against disaster. First came liquidity support by central banks; deposit insurance followed; in the latest crisis governments have given all creditors a blanket implicit guarantee. As a result, banks have been prepared to let their insulation wear thin. Going into the crisis, some Western institutions’ core capital was 3% of their assets or less, and less than a tenth of those assets were liquid. Government support may also have given banks an incentive to grow much bigger, so that most European countries now underwrite banking systems several times larger than their GDPs. As Andrew Haldane of the Bank of England has noted, the world has come a long way since 1360, when a banker in Barcelona was executed in front of his failed firm.
Such extensive government guarantees render redundant the normal laws of companies’ capital structure, which dictate that high leverage and over-reliance on short-term borrowing are a suicidal combination. A bank can operate with almost no equity, safe in the knowledge that it will still be able to borrow and raise deposits cheaply, because creditors know they are guaranteed. Furthermore, if a bank knows the state will always provide liquidity if markets dry up, it has a big incentive to rely on short-term borrowing (which is typically cheaper than long-term funds). It follows that if banks in a state-backed system are to have safety buffers, the state must determine their thickness and quality.
Third time lucky?
Since 1988 global capital rules have been set by the Basel Committee, a club of regulators which relies on national authorities to implement its standards. Basel 2, a souped-up version of the original rules, has been introduced by most European banks in the past two years. America’s big banks are on track to implement it by next year. It involves two stages. The first is defining capital: crudely, the gap between assets and liabilities. The second is comparing this with assets. Since not all assets are the same, the rules adjust them for risk, often using complicated modelling: a government bond is regarded as absolutely safe and so needs no capital behind it, but a risky property loan requires lots. The rules say that Tier 1 capital—supposedly, in the main, common equity and equity-like instruments—must be at least 4% of a bank’s risk-adjusted assets.
However, the definition of Tier 1 capital was far too lax. Many of the equity-like instruments allowed were really debt. In effect, the fine print allowed banks’ common equity, or “core” Tier 1, the purest and most flexible form of capital, to be as little as 2% of risk-adjusted assets. In hindsight, says one regulator, this was “very, very low… unacceptably low”. Furthermore, investors lost confidence in the way assets were adjusted for risk to compute a capital ratio. For instance, dodgy mortgage securities could be held with little capital against them, on the basis that credit-rating agencies had graded them triple-A. Risk-adjusted according to Basel 2, they were judged almost as safe as government bonds.
The new proposals go a long way to remedying these failures. The definition of capital will be much stricter. In essence, only pure equity will be included and that after deducting spurious benefits such as tax assets and including nasties such as short-term losses on securities. According to some estimates, that alone could wipe out much of the equity of several European banks, although the changes are likely to be introduced slowly. José María Roldán, of the Bank of Spain, who chairs the Basel club’s implementation committee, says “the more revolutionary we are”, the greater the need for a “slower transition”.
At the same time, risk-adjustment will become less dependent on firms’ own internal models, be harder on investment banks and encourage banks to cross-examine the credit ratings of their assets. For good measure the Basel club has also proposed a new liquidity regime that would require banks to be able to withstand a 30-day freeze in credit markets and force them to become less reliant on short-term wholesale funding. The tests, says an American official, are tough and have been “informed” by the crisis.
The big question: how much?
None of this really answers the all-important question of how much capital banks need. There is a trade-off between safety and economic growth: a bank that took no risks at all would not be much use in providing credit to companies or individuals. Getting this trade-off right is difficult. A 2009 study for Britain’s Financial Services Authority concluded that because periodic meltdowns do so much damage, banking systems should ideally be better capitalised and less volatile than they were before the crisis. The Basel club plans to do its own impact study over the next six months. “It is incredibly important” to get the trade-off right, says Peter Sands, chief executive of Standard Chartered.
Part of the answer, however, is plain: banks should have sufficient capital to survive a crisis as severe as the one Western financial systems have just suffered. This is the sum of two parts. The first is the minimum below which a typical bank loses the confidence of depositors, other creditors and its counterparties. This is largely a matter of mass psychology: the rule of thumb in the markets is that it has perhaps doubled to about 4% of risk-adjusted assets. This already has semi-official endorsement: both America’s and Britain’s recent “stress tests” used this as the floor.
On top of this, banks need enough capital to avoid breaching the 4% minimum in a market meltdown. Here, the experience of the crisis has already produced some guidance. The results of America’s stress tests suggest that the country’s big banks will, through their underlying losses, have eaten up capital worth about 4% of risk-weighted assets. A recent Bank of England study of banking crises since the late 1980s in Japan, Finland, Norway and Sweden found that the average bank ate up 4.5% of risk-adjusted assets.
Adding these two elements together implies that a typical bank should run with core equity capital of 8-9% of risk-adjusted assets, which would be eaten away to 4% during a crisis. Not surprisingly, most big banks are near this point after a bout of equity-raising. America’s four largest banks have core capital of $400 billion, almost twice as much as a year ago.
The view of most, but not all, regulators is that the absolute level of capital in the system is approaching acceptable levels. They still want to add more bells and whistles. Capital requirements for risky trading operations could rise by as much as three times. In anticipation of this, pure-play investment banks such as Goldman Sachs are running with core capital of more than 10% of risk-adjusted assets. To augment the capital rules, bad-debt provisions are likely to be more forward-looking. And how the new capital range is managed is still up for debate. Central banks, with their renewed desire to avert credit bubbles, are likely to take a keen interest. The Basel proposals include sanctions on firms that are close to the capital floor, preventing them from paying dividends.
Working out whether banks have already pre-empted the proposed liquidity requirements is more difficult. Some banks, such as Belgium’s Dexia and Britain’s HBOS, still rely heavily on state funding. But overall a dramatic shift towards long-term funding has taken place. Three-quarters of the balance-sheets of America’s four biggest banks are now funded by equity, long-term debt or deposits.
Yet for all this, a single, horrible truth exists. Because most big banks are too interconnected to fail, and could be brought down by a counterparty, the system is only as strong as its weakest member. Although the average American bank ate up about 4% of risk-adjusted assets in losses during the crisis, the worst banks consumed far more (see chart 2). Citigroup, HBOS and Belgium’s KBC, for example, lost 6-8% of risk-adjusted assets. At the crazy end of the spectrum, Merrill Lynch, which had lots of dodgy securities that were marked-to-market (so that losses were recognised upfront), lost 19%. It would have needed a core-capital ratio of 23% to avoid falling through the 4% floor. UBS lost 13%, implying that it would have required a ratio of 17%.
In part, cautions Bernard de Longevialle of Standard & Poor’s, this reflects the fact that the outlier banks’ calculations of risk-adjusted assets were out of whack. For example, subprime securities were treated as fairly safe. But nonetheless it is probably true that even with the right denominator, these firms would have needed capital ratios of far above 8-9% at the start of the crisis to avoid failure. The Bank of England’s research of other crises points to similar conclusions: the worst failed bank would have needed a core-capital ratio of 18% to stay above a 4% minimum.
Clearly, regulators could simply raise all banks’ capital to a level that would keep even the outliers from failure. But that would be prohibitively expensive. For America’s four giant banks, raising core capital to 20% of risk-adjusted assets could require them to raise an additional $30 billion-odd of annual income (to provide a return on that extra capital). If pushed through to customers, that might raise the weighted average interest rate they charge by roughly a percentage point, from 6% now. That would hurt economic growth.
An obvious answer to the problem of outliers is to impose losses on the riskiest banks further up banks’ capital structures, so that creditors rather than taxpayers suffer. Most banks already have additional slices of capital above equity. For example, at the end of 2008 Britain’s firms had core capital (tangible common equity) of about £200 billion ($290 billion), and on top of this another £200 billion of “quasi-capital” consisting of such exotica as hybrid capital and “Tier 2” securities. In essence these are junior forms of debt which in a bankruptcy would be hit before senior creditors, depositors and customers.
Illustration by Warrick Johnson-CadwellThe trouble with these instruments, however, is that if they end up bearing losses, the entire bank is usually judged to be in default, causing a stampede of counterparties, depositors and other senior creditors who fear they will lose too as the bank is wound up, destabilising the system as a whole. In the jargon, these instruments are unable to bear losses while a bank is a “going concern”.
Ideally, then there would be a layer of creditors who could absorb losses while the bank remained in business. The most concrete idea so far is “contingent convertible” capital, or Coco: debt that converts into equity if a bank gets into trouble. In November Britain’s Lloyds, which took over HBOS and was bailed out by the state in 2008, issued a Coco bond equivalent to 1.6% of risk-adjusted assets. It pays a coupon, like a normal bond, unless the bank’s core capital falls below 5% of risk-adjusted assets. At that point the coupon is cancelled and the bond converts into equity, boosting the bank’s ability to absorb losses while remaining a going concern. According to a London banker, people “all over the City are working” on similar ideas. Goldman Sachs has indicated it would consider issuing Coco bonds.
Cocos sound too good to be true, which is precisely what worries some observers. The idea “has the feeling of being a silver bullet,” says a lukewarm American regulator. Lloyds is paying a fairly high coupon of 10-11% to attract buyers to this novel security. That is almost as expensive as equity. And executives at other banks and some regulators worry that under extreme stress complex instruments rarely work as intended. Triggering the bond itself could cause a run: counterparties could take it as a signal that the bank was in severe trouble. Coco’s defenders tend to dismiss this risk—wrongly. In a crisis the degree of uncertainty about worst-case losses and mistrust of banks’ accounts becomes so high that counterparties run after any admission of trouble.
There are other niggles. The capital ratio at any given moment is highly dependent on when managers write down bad debts. A European bank boss paints a nightmare picture of Coco investors buying insurance “wrappers”, offloading the risk to another counterparty, in much the same way that American International Group, a once-mighty insurer, became a rubbish dump for the “tail risks” no one else wanted. If that happened to Cocos, they might merely shift losses from one place to another—and save taxpayers nothing in the end.
Between going and gone
Cocos deserve a chance, but there is an alternative. This is to try to create a middle state for banks between going concern and gone: a partial bankruptcy. Over the past year there has been much talk about creating “special resolution regimes” and “living wills” for failing banks. Many of these ideas are well-meaning waffle, little better than glorified contingency planning. Also of little use are some more macho notions doing the rounds. Simply giving a resolution authority the right to beat up all creditors would ensure that any bank at risk of falling under its auspices would face a run.
One option is to ring-fence the deposit-taking parts of banks and offer them a full guarantee. This would amount to a stealthy reimposition of the Glass-Steagall act, the Depression-era law that separated American commercial and investment banks, and would be hugely complicated. The alternative is to force banks to issue bonds that would automatically suffer partial losses in the event of state intervention, a little like Cocos. Either way, the objective would be to guarantee enough of an institution’s balance-sheet to avoid a run, while leaving enough of it without a guarantee to protect taxpayers from even the outlier banks.
That is not an easy balance to strike. But the risk now is that regulators retreat into designing cleverer ways to make the average bank safer, while ignoring the greater question. That is not how to make regulation cleverer, but how to protect taxpayers from a huge bill when all the precautions fail and a bank steps into the void.
The speed of the reaction is impressive and most of the proposals look sensible. Yet a feeling remains that the fine minds have evaded the really difficult question. If the banking system resembles a line of climbers roped together, then regulators are busy making the clothes warmer, the maps more accurate, the rations more filling and the whistles louder. Unfortunately none of that is any good if someone falls over the edge, as a handful of banks are wont to do in financial crises. Unless a way is found to solve this problem, taxpayers will remain destined to rescue the flakiest firms time and time again.
In part the focus on capital and liquidity buffers reflects the poverty of the alternatives. Breaking up banks is hard and of uncertain benefit. Having public-sector bureaucrats run them is as unattractive as leaving the discredited masters of the universe in charge. And despite promises that regulators will be cleverer and central bankers more alert, banks are certain to get into trouble again, as they always have. The way to protect taxpayers, the argument goes, is to compel banks to have buffers thick enough to withstand higher losses and longer freezes in financial markets before they call for state help.
The proposals have already been dubbed “Basel 3”—which tells you regulators have been here twice before. Alas, the record of bank-capital rules is crushingly bad. The Basel regime (European and American banks use either version 1 or 2) represents a monumental, decades-long effort at perfection, with minimum capital requirements carefully calculated from detailed formulae. The answers were precisely wrong. Five days before its bankruptcy Lehman Brothers boasted a “Tier 1” capital ratio of 11%, almost three times the regulatory minimum.
That poses an obvious question for bank supervisors: if they have already tried and failed to make capital rules foolproof, why should they do better this time? They do not just have to worry about rules being too slack. If they overreact to the financial crisis and devise rules that are too strict, they may endanger the recovery. And how can supervisors deal with the basket-case banks, for which no reasonable buffer will be adequate?
In the days when banks (and their customers) could not rely on governments to save them, they carried huge buffers to protect themselves against losses and drops in confidence. In the late 19th century a typical American or British bank had an equity buffer—ie, core capital—equivalent to 15-25% of its assets (see chart 1). As recently as the 1960s British banks held more than a quarter of their assets in low-risk, liquid form, such as cash or government bonds.
Over time governments have supplied more protection against disaster. First came liquidity support by central banks; deposit insurance followed; in the latest crisis governments have given all creditors a blanket implicit guarantee. As a result, banks have been prepared to let their insulation wear thin. Going into the crisis, some Western institutions’ core capital was 3% of their assets or less, and less than a tenth of those assets were liquid. Government support may also have given banks an incentive to grow much bigger, so that most European countries now underwrite banking systems several times larger than their GDPs. As Andrew Haldane of the Bank of England has noted, the world has come a long way since 1360, when a banker in Barcelona was executed in front of his failed firm.
Such extensive government guarantees render redundant the normal laws of companies’ capital structure, which dictate that high leverage and over-reliance on short-term borrowing are a suicidal combination. A bank can operate with almost no equity, safe in the knowledge that it will still be able to borrow and raise deposits cheaply, because creditors know they are guaranteed. Furthermore, if a bank knows the state will always provide liquidity if markets dry up, it has a big incentive to rely on short-term borrowing (which is typically cheaper than long-term funds). It follows that if banks in a state-backed system are to have safety buffers, the state must determine their thickness and quality.
Third time lucky?
Since 1988 global capital rules have been set by the Basel Committee, a club of regulators which relies on national authorities to implement its standards. Basel 2, a souped-up version of the original rules, has been introduced by most European banks in the past two years. America’s big banks are on track to implement it by next year. It involves two stages. The first is defining capital: crudely, the gap between assets and liabilities. The second is comparing this with assets. Since not all assets are the same, the rules adjust them for risk, often using complicated modelling: a government bond is regarded as absolutely safe and so needs no capital behind it, but a risky property loan requires lots. The rules say that Tier 1 capital—supposedly, in the main, common equity and equity-like instruments—must be at least 4% of a bank’s risk-adjusted assets.
However, the definition of Tier 1 capital was far too lax. Many of the equity-like instruments allowed were really debt. In effect, the fine print allowed banks’ common equity, or “core” Tier 1, the purest and most flexible form of capital, to be as little as 2% of risk-adjusted assets. In hindsight, says one regulator, this was “very, very low… unacceptably low”. Furthermore, investors lost confidence in the way assets were adjusted for risk to compute a capital ratio. For instance, dodgy mortgage securities could be held with little capital against them, on the basis that credit-rating agencies had graded them triple-A. Risk-adjusted according to Basel 2, they were judged almost as safe as government bonds.
The new proposals go a long way to remedying these failures. The definition of capital will be much stricter. In essence, only pure equity will be included and that after deducting spurious benefits such as tax assets and including nasties such as short-term losses on securities. According to some estimates, that alone could wipe out much of the equity of several European banks, although the changes are likely to be introduced slowly. José María Roldán, of the Bank of Spain, who chairs the Basel club’s implementation committee, says “the more revolutionary we are”, the greater the need for a “slower transition”.
At the same time, risk-adjustment will become less dependent on firms’ own internal models, be harder on investment banks and encourage banks to cross-examine the credit ratings of their assets. For good measure the Basel club has also proposed a new liquidity regime that would require banks to be able to withstand a 30-day freeze in credit markets and force them to become less reliant on short-term wholesale funding. The tests, says an American official, are tough and have been “informed” by the crisis.
The big question: how much?
None of this really answers the all-important question of how much capital banks need. There is a trade-off between safety and economic growth: a bank that took no risks at all would not be much use in providing credit to companies or individuals. Getting this trade-off right is difficult. A 2009 study for Britain’s Financial Services Authority concluded that because periodic meltdowns do so much damage, banking systems should ideally be better capitalised and less volatile than they were before the crisis. The Basel club plans to do its own impact study over the next six months. “It is incredibly important” to get the trade-off right, says Peter Sands, chief executive of Standard Chartered.
Part of the answer, however, is plain: banks should have sufficient capital to survive a crisis as severe as the one Western financial systems have just suffered. This is the sum of two parts. The first is the minimum below which a typical bank loses the confidence of depositors, other creditors and its counterparties. This is largely a matter of mass psychology: the rule of thumb in the markets is that it has perhaps doubled to about 4% of risk-adjusted assets. This already has semi-official endorsement: both America’s and Britain’s recent “stress tests” used this as the floor.
On top of this, banks need enough capital to avoid breaching the 4% minimum in a market meltdown. Here, the experience of the crisis has already produced some guidance. The results of America’s stress tests suggest that the country’s big banks will, through their underlying losses, have eaten up capital worth about 4% of risk-weighted assets. A recent Bank of England study of banking crises since the late 1980s in Japan, Finland, Norway and Sweden found that the average bank ate up 4.5% of risk-adjusted assets.
Adding these two elements together implies that a typical bank should run with core equity capital of 8-9% of risk-adjusted assets, which would be eaten away to 4% during a crisis. Not surprisingly, most big banks are near this point after a bout of equity-raising. America’s four largest banks have core capital of $400 billion, almost twice as much as a year ago.
The view of most, but not all, regulators is that the absolute level of capital in the system is approaching acceptable levels. They still want to add more bells and whistles. Capital requirements for risky trading operations could rise by as much as three times. In anticipation of this, pure-play investment banks such as Goldman Sachs are running with core capital of more than 10% of risk-adjusted assets. To augment the capital rules, bad-debt provisions are likely to be more forward-looking. And how the new capital range is managed is still up for debate. Central banks, with their renewed desire to avert credit bubbles, are likely to take a keen interest. The Basel proposals include sanctions on firms that are close to the capital floor, preventing them from paying dividends.
Working out whether banks have already pre-empted the proposed liquidity requirements is more difficult. Some banks, such as Belgium’s Dexia and Britain’s HBOS, still rely heavily on state funding. But overall a dramatic shift towards long-term funding has taken place. Three-quarters of the balance-sheets of America’s four biggest banks are now funded by equity, long-term debt or deposits.
Yet for all this, a single, horrible truth exists. Because most big banks are too interconnected to fail, and could be brought down by a counterparty, the system is only as strong as its weakest member. Although the average American bank ate up about 4% of risk-adjusted assets in losses during the crisis, the worst banks consumed far more (see chart 2). Citigroup, HBOS and Belgium’s KBC, for example, lost 6-8% of risk-adjusted assets. At the crazy end of the spectrum, Merrill Lynch, which had lots of dodgy securities that were marked-to-market (so that losses were recognised upfront), lost 19%. It would have needed a core-capital ratio of 23% to avoid falling through the 4% floor. UBS lost 13%, implying that it would have required a ratio of 17%.
In part, cautions Bernard de Longevialle of Standard & Poor’s, this reflects the fact that the outlier banks’ calculations of risk-adjusted assets were out of whack. For example, subprime securities were treated as fairly safe. But nonetheless it is probably true that even with the right denominator, these firms would have needed capital ratios of far above 8-9% at the start of the crisis to avoid failure. The Bank of England’s research of other crises points to similar conclusions: the worst failed bank would have needed a core-capital ratio of 18% to stay above a 4% minimum.
Clearly, regulators could simply raise all banks’ capital to a level that would keep even the outliers from failure. But that would be prohibitively expensive. For America’s four giant banks, raising core capital to 20% of risk-adjusted assets could require them to raise an additional $30 billion-odd of annual income (to provide a return on that extra capital). If pushed through to customers, that might raise the weighted average interest rate they charge by roughly a percentage point, from 6% now. That would hurt economic growth.
An obvious answer to the problem of outliers is to impose losses on the riskiest banks further up banks’ capital structures, so that creditors rather than taxpayers suffer. Most banks already have additional slices of capital above equity. For example, at the end of 2008 Britain’s firms had core capital (tangible common equity) of about £200 billion ($290 billion), and on top of this another £200 billion of “quasi-capital” consisting of such exotica as hybrid capital and “Tier 2” securities. In essence these are junior forms of debt which in a bankruptcy would be hit before senior creditors, depositors and customers.
Illustration by Warrick Johnson-CadwellThe trouble with these instruments, however, is that if they end up bearing losses, the entire bank is usually judged to be in default, causing a stampede of counterparties, depositors and other senior creditors who fear they will lose too as the bank is wound up, destabilising the system as a whole. In the jargon, these instruments are unable to bear losses while a bank is a “going concern”.
Ideally, then there would be a layer of creditors who could absorb losses while the bank remained in business. The most concrete idea so far is “contingent convertible” capital, or Coco: debt that converts into equity if a bank gets into trouble. In November Britain’s Lloyds, which took over HBOS and was bailed out by the state in 2008, issued a Coco bond equivalent to 1.6% of risk-adjusted assets. It pays a coupon, like a normal bond, unless the bank’s core capital falls below 5% of risk-adjusted assets. At that point the coupon is cancelled and the bond converts into equity, boosting the bank’s ability to absorb losses while remaining a going concern. According to a London banker, people “all over the City are working” on similar ideas. Goldman Sachs has indicated it would consider issuing Coco bonds.
Cocos sound too good to be true, which is precisely what worries some observers. The idea “has the feeling of being a silver bullet,” says a lukewarm American regulator. Lloyds is paying a fairly high coupon of 10-11% to attract buyers to this novel security. That is almost as expensive as equity. And executives at other banks and some regulators worry that under extreme stress complex instruments rarely work as intended. Triggering the bond itself could cause a run: counterparties could take it as a signal that the bank was in severe trouble. Coco’s defenders tend to dismiss this risk—wrongly. In a crisis the degree of uncertainty about worst-case losses and mistrust of banks’ accounts becomes so high that counterparties run after any admission of trouble.
There are other niggles. The capital ratio at any given moment is highly dependent on when managers write down bad debts. A European bank boss paints a nightmare picture of Coco investors buying insurance “wrappers”, offloading the risk to another counterparty, in much the same way that American International Group, a once-mighty insurer, became a rubbish dump for the “tail risks” no one else wanted. If that happened to Cocos, they might merely shift losses from one place to another—and save taxpayers nothing in the end.
Between going and gone
Cocos deserve a chance, but there is an alternative. This is to try to create a middle state for banks between going concern and gone: a partial bankruptcy. Over the past year there has been much talk about creating “special resolution regimes” and “living wills” for failing banks. Many of these ideas are well-meaning waffle, little better than glorified contingency planning. Also of little use are some more macho notions doing the rounds. Simply giving a resolution authority the right to beat up all creditors would ensure that any bank at risk of falling under its auspices would face a run.
One option is to ring-fence the deposit-taking parts of banks and offer them a full guarantee. This would amount to a stealthy reimposition of the Glass-Steagall act, the Depression-era law that separated American commercial and investment banks, and would be hugely complicated. The alternative is to force banks to issue bonds that would automatically suffer partial losses in the event of state intervention, a little like Cocos. Either way, the objective would be to guarantee enough of an institution’s balance-sheet to avoid a run, while leaving enough of it without a guarantee to protect taxpayers from even the outlier banks.
That is not an easy balance to strike. But the risk now is that regulators retreat into designing cleverer ways to make the average bank safer, while ignoring the greater question. That is not how to make regulation cleverer, but how to protect taxpayers from a huge bill when all the precautions fail and a bank steps into the void.
Saturday, January 16, 2010
banking reforms
Bank Reforms Boost Nigeria’s Efforts to Mitigate Impact of Financial Crisis
19/11/2008
"The Government of Nigeria will continue with its efforts to consolidate its financial and banking sector reforms in order to cushion the effects of the current global financial meltdown on the Nigerian economy," the Chargé d’affaires of the Nigerian Embassy in Tunisia, Abdel Kader Musa, has said.
Mr. Kader made the revelation while addressing the recent Conference of African Ministers of Finance and Central Bank Governors on the Global Financial Crisis in Tunis, Tunisia, where he represented his country’s ministry of finance and central Bank. The chargé d’affaires said the government had injected nearly 1. 7 trillion Naira (NGR 183.325 = 1US$) into the system and had taken relevant regulatory and supervisory actions whose scope extends to non-bank financing institutions. Pension funds, insurance and macro-finance institutions in Nigeria have been regulated, Mr. Musa emphasized.
While the international community struggles to come to grips with the analytical tools to understand the full dimension of the financial crisis, Mr. Musa explained that the Nigerian government had already intensified its efforts towards economic diversification and efficient utilization of domestic resources, under its 7-Point Framework Agenda. The country’s government has further increased allocations to support infrastructure development, especially in the energy sector.
The Nigerian government’s quick response to the crisis becomes more significant in the light of the country’s position in the ECOWAS sub-region, he said, concluding that "Nigeria will do everything possible to enhance its efforts to foster strong regional integration as a means of mitigating the financial crisis".
19/11/2008
"The Government of Nigeria will continue with its efforts to consolidate its financial and banking sector reforms in order to cushion the effects of the current global financial meltdown on the Nigerian economy," the Chargé d’affaires of the Nigerian Embassy in Tunisia, Abdel Kader Musa, has said.
Mr. Kader made the revelation while addressing the recent Conference of African Ministers of Finance and Central Bank Governors on the Global Financial Crisis in Tunis, Tunisia, where he represented his country’s ministry of finance and central Bank. The chargé d’affaires said the government had injected nearly 1. 7 trillion Naira (NGR 183.325 = 1US$) into the system and had taken relevant regulatory and supervisory actions whose scope extends to non-bank financing institutions. Pension funds, insurance and macro-finance institutions in Nigeria have been regulated, Mr. Musa emphasized.
While the international community struggles to come to grips with the analytical tools to understand the full dimension of the financial crisis, Mr. Musa explained that the Nigerian government had already intensified its efforts towards economic diversification and efficient utilization of domestic resources, under its 7-Point Framework Agenda. The country’s government has further increased allocations to support infrastructure development, especially in the energy sector.
The Nigerian government’s quick response to the crisis becomes more significant in the light of the country’s position in the ECOWAS sub-region, he said, concluding that "Nigeria will do everything possible to enhance its efforts to foster strong regional integration as a means of mitigating the financial crisis".
Monday, January 4, 2010
Banks and sovereign-wealth funds
The smart and the not-so-smart
YOUR phone rings at 3am. It’s a senior American banker sounding desperate. An unidentified heavy-breather—the treasury secretary?—is also on the line. It’s the opportunity of a lifetime, the banker swears: the chance to buy a multibillion-dollar stake in a big Wall Street firm. By the way, he adds breezily, any chance of an answer right away?
Most sovereign-wealth funds (SWFs) got an invitation of this sort between November 2007 and January 2008. Within a few weeks some $40 billion was poured into distressed Western lenders, among them Citigroup, UBS, Morgan Stanley and Merrill Lynch. Now SWFs are selling out. This month the Kuwait Investment Authority, the oldest SWF, sold a $4 billion stake in Citigroup, claiming a $1.1 billion profit. In September one of Singapore’s two investment vehicles, GIC, sold part of its stake in Citi, realising a $1.6 billion profit.
Click here to find out more!
Were SWFs right to buy? They piled in far too soon. It took another year for share prices to hit bottom; despite this year’s rally, they are still below the levels when SWFs invested, typically using convertible stock. Plenty made mistakes: Temasek, Singapore’s other state fund, sold out of Bank of America early this year, probably at a loss. Nor should the near misses be forgotten. In mid-2007 China Development Bank (strictly speaking a firm, not a fund) and Temasek offered to buy $13 billion of Barclays’ shares, at about twice today’s price, if its bid for ABN AMRO succeeded.
The winners fall into two camps. Some waited until prices had fallen further before buying. Qatar’s investment fund and prominent individuals in Qatar and Abu Dhabi participated in Barclays’ capital raisings in June and October last year and have made money. Others negotiated well. Kuwait and GIC invested in Citigroup in January 2008 but the fine print protected them from share-price falls. The Abu Dhabi Investment Authority, by contrast, invested $7.5 billion in Citi in November 2007 in less secure convertible instruments. It is likely to end up nursing a large loss.
The banking crisis was a baptism of fire. Most SWFs are still keen on strategic investments but only in healthy firms where there is a clearer national interest. About two-thirds of their deals in this quarter have been in natural resources. Gay Huey Evans of Barclays Capital reckons this trend will continue.
YOUR phone rings at 3am. It’s a senior American banker sounding desperate. An unidentified heavy-breather—the treasury secretary?—is also on the line. It’s the opportunity of a lifetime, the banker swears: the chance to buy a multibillion-dollar stake in a big Wall Street firm. By the way, he adds breezily, any chance of an answer right away?
Most sovereign-wealth funds (SWFs) got an invitation of this sort between November 2007 and January 2008. Within a few weeks some $40 billion was poured into distressed Western lenders, among them Citigroup, UBS, Morgan Stanley and Merrill Lynch. Now SWFs are selling out. This month the Kuwait Investment Authority, the oldest SWF, sold a $4 billion stake in Citigroup, claiming a $1.1 billion profit. In September one of Singapore’s two investment vehicles, GIC, sold part of its stake in Citi, realising a $1.6 billion profit.
Click here to find out more!
Were SWFs right to buy? They piled in far too soon. It took another year for share prices to hit bottom; despite this year’s rally, they are still below the levels when SWFs invested, typically using convertible stock. Plenty made mistakes: Temasek, Singapore’s other state fund, sold out of Bank of America early this year, probably at a loss. Nor should the near misses be forgotten. In mid-2007 China Development Bank (strictly speaking a firm, not a fund) and Temasek offered to buy $13 billion of Barclays’ shares, at about twice today’s price, if its bid for ABN AMRO succeeded.
The winners fall into two camps. Some waited until prices had fallen further before buying. Qatar’s investment fund and prominent individuals in Qatar and Abu Dhabi participated in Barclays’ capital raisings in June and October last year and have made money. Others negotiated well. Kuwait and GIC invested in Citigroup in January 2008 but the fine print protected them from share-price falls. The Abu Dhabi Investment Authority, by contrast, invested $7.5 billion in Citi in November 2007 in less secure convertible instruments. It is likely to end up nursing a large loss.
The banking crisis was a baptism of fire. Most SWFs are still keen on strategic investments but only in healthy firms where there is a clearer national interest. About two-thirds of their deals in this quarter have been in natural resources. Gay Huey Evans of Barclays Capital reckons this trend will continue.
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