Wednesday, February 1, 2012

Banking in a market economy

The Bank of England's Paul Tucker has written an interesting paper on banking in a market economy.  In it, he neatly summarizes how banking and capital markets have merged over the last 3 decades.
A generation or so ago, we could have relied upon separate regimes for banking and for securities markets. In that far-off world, banks extended and held illiquid loans, overseen by
banking supervisors. And, in a largely separate universe, securities regulators policed the integrity of individual transactions and offerings on public exchanges served by specialist intermediaries. 
The growth of private markets – over-the-counter, derivatives, securitisation – and of banks as intermediaries in capital markets has changed all that, as the 2007–09 crisis cruelly exposed. 
The revolution, whether we like it or not, has been the fusion of banking and capital markets. 
Even the most limited forms of commercial banking involve hedging of customer business in interest-rate and foreign-exchange markets. Wholesale loans to medium-sized and large companies, loans that are syndicated and traded, lie in the intersection of commercial and investment banking. 
The solutions to the problems of global finance have to cover securities markets as well
as banking.
I would ask that you re-read his summary as it highlights several critical issues.
  • Securities regulators have historically deferred to the primacy of bank regulators for all bank related matters.
  • Banking and capital markets have fused; and 
  • Solutions have to cover both the securities market and banking.
These observations give rise to a question:  where in all of the new regulations enacted since the start of the financial crisis on August 9, 2007 is the solution that a securities regulator would naturally adopt?

Since the Great Depression, capital markets in the US and Europe have been based on the philosophy of disclosure.  Specifically, the idea that market participants must have access to all the useful, relevant information in an appropriate, timely manner.  Securities regulators were given the responsibility for making sure this occurs.

Given this responsibility, how would securities regulators have fulfilled their responsibility that banks disclose all their useful, relevant information if banking supervisors did not exist?

Would the securities regulators have adopted the same disclosure that we have now that the Bank of England's Andy Haldane says leaves banks resembling 'black boxes'?

Or, would the securities regulators have adopted ultra transparency and required banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details?

There is reason to believe that securities regulators would have adopted ultra transparency because this is the information that bank supervisors have access to and use so that they can oversee banks.


creditplumber said...

I agree with your comments. However, Tucker also mentioned insurance; "the fusion of capital markets, banking and insurance". Insurance balance sheets can take infinite risk with finite capacity unlike banks. Risk transparency/ utmost good faith is a corollary in the insurance and reinsurance industry. Banking, on the other hand shrouds risk, profits from loss, requires no insurable interest re-hypothecates asset multiple times and trades risk on a secondary market with no retention by the seller. There are a great number of benefits for the Real Economy and risk transparency from greater fusion of insurance, capital market and banking methodologies.

Richard said...

Thanks for the excellent comment.

A small point of clarification. The passage I quoted does not have the "fusion of capital markets, banking and insurance". He introduces that later in his paper.