Thursday, April 12, 2012

Group of 30: Bank Investors 'too removed from action' to effect 'safety and soundness' of bank directly

The Group of 30, composed of former central bankers, regulators and bank bosses, issued a new report on governance of financial institutions.

According to a Telegraph article,

The world's biggest banks must do more to reduce the threat of another financial crisis by improving their corporate governance.
Why the emphasis on improving corporate governance?

While encouraging shareholders to ask difficult questions of a bank's management, the report is sceptical that investors can ultimately provide the sort of scrutiny that is required. 
"They are simply too removed from the action," the study finds of investors. "They are therefore not likely to make a real difference to the safety and soundness of the institution directly."
In short, without ultra transparency, shareholders cannot enforce their version of market discipline on the financial institutions that they have an ownership stake.

As your humble blogger has pointed out repeatedly, requiring the banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details is necessary if market participants are going to independently assess the risk of each bank and adjust the amount and price of their exposures based on this assessment.

Without this data being disclosed, market discipline is non-existent because it is impossible to assess risk.  As a result, market participants rely on regulators and Boards of Directors.

The problem with relying on regulators is they have to both accurately assess the risk of each bank and communicate this risk to the market.  In a time of regulatory forbearance, clearly risk is not being communicated.

The problem with the Board of Directors is they don't have the resources to independently assess the data that the market does.  As a result, they are dependent on management's assessment of the risk.  The Group of 30 tried to propose a rule to lessen directors' reliance on management

If a risk is too complicated for a well-composed board to understand, it is too complicated to accept.
Your humble blogger prefers a related, but different rule:  if management would not be willing to disclose the risk to market participants, then the risk should not be accepted.

The result of this rule is ultra transparency.  After all, if management is willing to disclose the risks, there is no reason not to disclose all the exposure details.

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