"Banking enters a new world order"

Harry Wilson wrote a must read article for the Telegraph on the need for banks to provide disclosure of their current assets and liabilities.

This point was seconded by Georges Pauget, an advisor to the French government and former chief executive of Credit Agricole, and Lord Myners, the former City minister.

Last week, it was the turn of France's major banks, in particular Societe Generale, to feel the white heat of investor fears as its share price performed the sort of manoeuvres that are normally the preserve of penny stocks. 

The reasons given for the, at times, 20pc falls in the Soc Gen share price varied. One moment it was the potential victim of downgrade in French government bonds, next there were hidden equity derivative trading losses, at other times it was facing a funding crunch and had its credit lines pulled. 

Underlying it all was the sense that Soc Gen and banks in general have not been upfront about the problems they face and are playing a trillion pound game of chicken with investors, creditors and central banks. 

That markets may feel banks have not been entirely truthful is understandable. Over a period of 12 months from early 2008 into 2009 a series of banks, brokers and mutuals collapsed or were nationalised often only weeks, days or hours after insisting they had no problems whatsoever. 

Bear Stearns, Lehman Brothers, Fortis, Royal Bank of Scotland and many others had said they were fine, until they were not, often leaving customers and investors sitting on huge losses. 

Indeed, any fund that withdrew its custom and shorted the banks' shares the moment a chief executive appeared on a conference call to say all was well would not only have avoided large losses, but made a lot of money too. 

The lessons were learned: suspect everything a bank says, and never be the last
one out the door. 

Trust, but verify.

Banks and regulators are alive to the problem and the industry stress tests run by the European Banking Authority have attempted to counter the suspicions. 

Unfortunately, they appear to have failed. 

Who would believe the regulators after they let the solvency crisis occur in the first place?  When it comes to stress tests, European regulators have absolutely zero credibility after banks in Ireland passed a stress test and were nationalized two months later.

Detailed breakdowns of government bond exposures and a raft of other information on their risks have not comforted investors who now want more details of how banks are funded. 

As predicted under the FDR Framework, market participants want the information so that they can do their own analysis.  The detailed breakdowns served to show how little information is available.

It is in the banking industry's interests to provide this disclosure, but as before with the issue of sovereign debt, banks are not being as forthcoming as they might. 

While bankers will cry "commercial sensitivity", investors will think the worst.

Regular readers know that because banks are backed by their governments, the need for disclosing all the useful, relevant information to market participants so they can assess a bank's solvency takes precedence over commercial sensitivity concerns.

You only need to look at European bank credit default swaps, essentially insurance against their collapse.  In some cases, the CDS on financial institutions is trading at higher levels than at the peak of the financial crisis in 2008 and for most banks they are continuing to widen. 

CDS is not an exact proxy for a bank's borrowing costs, but it is fair to assume the cost of funding is rising for many, indeed, Bank of Ireland, the only Irish bank not to be nationalised, returned to loss in the first half largely because of a sharp rise in its financing costs. 

This situation will only get worse if it is not addressed swiftly. 

This is a point I have been making since before the start of the solvency crisis in 2007.

Already a host of peripheral eurozone savings banks have effectively become wards of the European Central Bank and more than 50pc of excess deposits within the currency union – a higher proportion than after Lehman Brothers collapsed – are being recycled daily to prop up weaker banks that have been shut out of the interbank market.

Banks do not lend to each other when they think that the counter-party is insolvent.  This is what froze the interbank market in 2008 and is forcing the ECB to act as an intermediary in 2011.

The only way to restore direct interbank lending is by disclosing each bank's current asset and liability-level data.  The bank that is lending money can and knows how to use this data to determine the price and amount of their exposure to any borrowing bank.

Like the sovereign debt crisis, of which it is an ancillary, the developing European banking crisis can only begin to be resolved if banks and regulators are upfront about the problems the sector faces and are prepared to take radical action to deal with them. 

Given the opacity that has shrouded the banking industry since before the crisis has been preserved by the regulators, requiring disclosure of the current asset and liability-level data would be a radical action.