Tuesday, February 7, 2012

Financial Times sees need to shine light on bank exposures

In an editorial, Europe cannot make bank risk go away, the Financial Times endorsed the need to shine light on bank exposures.

Regular readers must be thinking that ultra transparency is an idea whose time has come.  One day, a Nobel prize winning economist, Joseph Stiglitz, is saying the need for transparency is one of the main lessons of the financial crisis of 2008.

The next, the Financial Times is calling for transparency so that the risks in the European banking system can be assessed and addressed.

The European Banking Authority’s board of supervisors will meet this week amid reports that the body is in a tug-of-war with banks and national regulators over how to fill capital shortfalls identified by the pan-European body last year. The noise will only intensify as a June compliance deadline draws closer, for it reflects deep contradictions in Europe’s banking policy. 
It has long been plain that European banks need more light shone on their exposures and a stronger capital footing. 
The EBA did its part of the job by recommending that national authorities require bank capital ratios of 9 per cent after discounting sovereign debt holdings. Sadly, the other pieces of the puzzle, in particular a concrete and credible plan for banks unable or unwilling to find the capital by themselves, are limited to rhetoric.
Sadly, the other piece of the puzzle, namely ultra transparency, has not been addressed.

The inability of banks to find capital is directly related to the lack of ultra transparency.

With ultra transparency, banks disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  Market participants use this information to independently assess each banks risk and adjust the amount and price of their exposure based on this assessment.

Without ultra transparency, market participants see banks as 'black boxes'.  Market participants know that risk is being hidden and cannot assess the risk of the banks.  As a result, they are not interested in investing additional capital in the banks.
Not all national authorities – be they regulators or governments – see eye to eye with the EBA on capital adequacy. In part they fear that tampering with banks could disrupt credit to fragile economies.... 
Resistance also grows from the sector’s incestuous relations with national governments. Many countries find little reason to insist on capital reserves as they see banking as an extension of the state. The result is that taxpayers subsidise banks implicitly in good times, explicitly in bad times, and suicidally in a sovereign debt crisis. Governments should not tolerate the transfer of wealth involved in taxpayers bearing the risk – and a growing number of them can no longer afford to in any case.
The question screaming for a credible answer is: what will happen to banks that fall short of the required capital-raising? Only a few states can still bail theirs out. Others are promised help from the eurozone rescue fund. If this takes the form of a loan to the responsible state, however, it may simply precipitate a bank-sovereign downward spiral. The alternative is bank debt restructuring, which the eurozone refuses to contemplate.
 ... The fiscal authority and legal ability to sanitise banks remains with states....
There is another alternative that this blog has discussed at great length that the states could implement.  Simply put, recognize that while banks are hiding their risks, capital is meaningless.

Instead, regulators should focus on requiring banks to provide ultra transparency and requiring the banks to recognize all of the losses on and off their balance sheets.

Having recognized their losses, banks can now recapitalize through a combination of future retained earnings and equity issuance.
Europe can hide risks in its banking system; it cannot make them go away.

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