This statement is the logical conclusion of the Bank of England's plan to substitute market discipline for bank examination. As discussed in an earlier blog, Bank of England Adopting 21st Century Oversight of Financial Institutions, the current model of bank examination does not work.
The current bank examination model, as practiced by regulators like the Financial Services Authority and Federal Reserve, involves sending out large numbers of examiners to look through the banks' books, demanding lots of detailed information for their internal review and asking the banks to run stress tests on assumptions the regulators provide. A key feature of this model is that no detailed information is shared with the markets.
If this model looks like it parallels how the rating agencies operate, it does. The parallel in the US goes all the way to the issuance of a CAMELS rating by the regulator. A CAMELS rating is for regulators eyes only and is a reflection of a bank's overall condition in the areas of capital adequacy (C), asset quality (A), management (M), earnings (E), liquidity (L) and sensitivity to market risk (S).
Just like the ratings produced by the rating agencies, since the markets do not have the information to do their own homework, the markets have to trust that the regulators get their ratings right. Unfortunately, recent history shows that regulators were just like the rating agencies and they did not always get their ratings right.
According to a WSJ article, "a top Bank of England official, Andy Haldane, said the new regulator will curtail the FSA's practice of dispatching dozens of examiners to banks to collect loads of granular information... Mr. Haldane noted that ... they rarely yield much useful information for regulators, who can find themselves overwhelmed by the quantity of data."
Mr. Haldane identified the flaw in the bank examination model and the reason that regulators need to have banks disclose more information to the markets.
The markets are not overwhelmed by the quantity of data disclosed by financial institutions. There are a number of market participants who are able to and have an incentive to analyze all of the individual asset level data these institutions could provide and turn it into useful information.
Andrew Redleaf, a hedge fund manager, takes the idea of banks disclosing data and market participants using this data further.
On February 23, 2009, in a Wired article, Daniel Roth provided the support for Mr. Haldane's observation and solution in much more detail.
"Even the regulators can't keep up. A Senate study in 2002 found that the SEC had managed to fully review just 16 percent of the nearly 15,000 annual reports that companies submitted in the previous fiscal year; the recently disgraced Enron hadn't been reviewed in a decade. We shouldn't be surprised. While the SEC is staffed by a relatively small group of poorly compensated financial cops, Wall Street bankers get paid millions to create new and ever more complicated investment products. By the time regulators get a handle on one investment class, a slew of new ones have been created. 'This is a cycle that goes on and on—and will continue to get repeated,' says Peter Wysocki, a professor at the MIT Sloan School of Management. 'You can't just make new regulations about the next innovation in financial misreporting.'
That's why it's not enough to simply give the SEC—or any of its sister regulators—more authority; we need to rethink our entire philosophy of regulation. Instead of assigning oversight responsibility to a finite group of bureaucrats, we should enable every investor to act as a citizen-regulator. We should tap into the massive parallel processing power of people around the world by giving everyone the tools to track, analyze, and publicize financial machinations. The result would be a wave of decentralized innovation that can keep pace with Wall Street and allow the market to regulate itself—naturally punishing companies and investments that don't measure up—more efficiently than the regulators ever could.
Tracking Wall Street's complex inventions may be difficult for regulators, but it's a snap given the right software....When data is kept under lock and key, as mysterious as a temple secret, only the priests can read and interpret it. But place it in the public domain and suddenly it takes on new life. People start playing with the information, reaching strange new conclusions or raising questions that no one else would think to ask. It is impossible to predict who will become obsessed with the data or why—but someone will.
How can the disclosure pushed by regulators like Haldane and investors like Redleaf actually be implemented?
By creating the "mother of all databases." This is the database that your humble blogger has been pushing since before the credit crisis (here, here and here) and is necessary if European investors are going to be able to comply with the 'know what you own" provision of Article 122a of the European Capital Requirements Directive.
This is the database that the Office of Financial Research and Data (OFR) is suppose to develop, but because it is a governmental entity never will. OFR is fundamentally handicapped because:
- The current operating philosophy of the regulators is not to share detailed information with the market.
- By law it must, where possible, use information collected by other governmental agencies. What if the frequency that another governmental agencies collects data, say monthly, is not what is required to, as Lloyd Blankfein advised, monitor every position every day?
What is required is an independent third party to run the mother of all databases. The independent third party must only be in the business of managing this database. This assures all market participants that the database is free of all conflicts of interest and they can trust the numbers.