Bank reform can't wait

In a column in the Guardian, Robert Jenkins, a member of the BoE's Financial Policy Committee, flatly states that bank reform can't wait.

Absolutely true.

He then goes on to urge the implementation of the Vicker's Commission proposals.

This just goes to show that once again the banking industry can count on economists and regulators to get in the way of bankers adopting the only reform that matters - ongoing disclosure of their current asset, liability and off-balance sheet exposure details.

Let us imagine that banks fully comply with the Commission's proposals over the next 24 months.

Will banks be any closer to telling which of their competitors are solvent and which are insolvent?

Where does the excess leverage and bad debt that currently exists in the financial system go under Vickers?  This includes sovereign debt, consumer debt (including mortgages), commercial real estate debt and those toxic subprime securities.

Given the massive amount of regulatory forbearance that has occurred to date, is there any reason to believe that all the losses will be recognized over the next 24 months?

If these losses are not recognized, how can market participants tell if the "bank" inside the ring-fence is solvent or not?

In his Independent Commission on Banking report, John Vickers produced a good plan. It should be implemented within 24 months. Such a timetable will shock several bankers ... Why wait? 

The coalition moved quickly to create the commission and Vickers began its work in mid-2010. The objectives were formidable. These included: reduce systemic risk; mitigate moral hazard; reduce the likelihood and impact of bank failure; shrink subsidies to investment banks; and increase competition in retail banking.... 

All of which would be better achieved by simply requiring current disclosure of each bank's asset, liability and off-balance sheet exposure details.

With this disclosure, market discipline, which has been blocked by the regulators' information monopoly for the last 80 years would be reintroduced to the banking industry.

Systemic risk would be reduced as each bank adjusts the amount and price of its exposure to other banks to reflect these banks' riskiness and the chance of loss.

Moral hazard would be mitigated because each bank would know that the government is not going to bailout any of the banks and that they are responsible for the losses on their exposures.

The likelihood of bank failure would be reduced as an increase in a bank's cost of funds as it adds risks acts as a disincentive to add risk.  In fact, market discipline would push banks to reduce their risk profile as high returns with low risk is what the market will pay a premium for.

The parts of investment banking focused on proprietary trading and not market making would be reduced as everyone could see the bank's positions and potentially trade against or front run the purchase or sale of this position.

The Vickers proposal, published in September, goes a long way towards meeting these challenges. It places the interests of depositors ahead of equity and bondholders. It largely "ringfences" retail and small business banking from investment banking. And it calls for the ringfenced entity to be better capitalised than currently required. In short, it seeks to make safer that part of banking critical to households and businesses....

Really?  How can a market participant know if the part of banking critical to households and businesses is safer if they cannot tell if it is solvent or not?

There are only two possible justifications for delay. The first is the risk of adversely affecting the supply and cost of credit to an important sector of the economy at a time of financial fragility. The commission's analysis suggests it will not. A separate report by accountants Ernst & Young concurs.

Oops...Lord Turner, head of the Financial Services Administration has recently come out and said that requiring banks to reach a 9% Tier I capital ratio is adversely affecting the supply of credit and there is nothing that regulators can do about it (see here).

The second reason is that banks would be unable to execute the reorganisation within the foreseeable future. This is absurd....

This is not to say implementation will be easy. There will be contracts to rewrite, legal vehicles to establish, and boards to recruit. Most of all, there will be choices to be made between what activities go where. Such choices will require thought – but no more or less than that which goes into any number of routine strategic reviews. And yes, there will be many unanticipated problems – there always are. But the sooner we start the sooner we will resolve them....

Why would you want to jump through all of these implementation difficulties when simply requiring on-going detailed current disclosure gets the same benefits without the headaches?

Why are we timid when it comes to financial reform? Is it that we are intimidated by those for whom the reforms are destined? 

Given that the Vicker's Commission did not adopt requiring banks to make ongoing detailed current disclosure, the evidence is clear for either cognitive capture by Wall Street's Opacity Protection Team or both timidity and intimidation.

Remember, FDR publicly invited the wrath of the bankers as opposed to deferring to the bankers when it came to disclosure.

There is one major danger in implementing Vickers quickly: that having taken this bold step we will be lulled into thinking the regulatory job is over. It will not be. Over-leveraged banks operating outside the ringfence will still threaten financial stability. But knowing this should not deter us from solving those problems we can fix now... 

Unlike the implementing Vickers, implementing detailed current disclosure also addresses the over-leveraged banks operating outside the ringfence that could threaten financial stability.

Which raises the question of why would you risk being lulled into thinking the regulatory job is over by implementing Vickers?