Spain confirms bank oversight model broken and needs to be replaced

As Spain repeats the mistakes made by Ireland and hires third parties to determine the size of the losses hidden in its banking system, Spain confirms that the bank oversight model is broken and needs to be replaced.

If there is any number that the banking regulators who are overseeing the Spanish banks (or the Irish banks or the Italian banks or the French banks or ....) should know it is the losses currently in the banking system.

Why should they know the total losses in the banking system?

The bank regulators are suppose to be using their monopoly on all the useful, relevant information about each financial institution's current asset, liability and off-balance sheet exposure details to assess the institution.  Any assessment would include knowing the losses on and off each bank's balance sheet.

Furthermore, bank regulators have examiners who go through each financial institution's loans.  The purpose of this review is to make sure the banks are not hiding bad loans.

Of course, with regulatory forbearance, even if a bad loan is identified by the examiner, the bank does not have to disclose this to other market participants.  However, the fact that a bad loan exists should still be known to the bank regulators.  So there is no excuse for the bank regulators not knowing with a great deal of precision the losses in the banking system.

The fact is the Spanish government has lost credibility from its pronouncements about the size of the losses in the banking system.  Each time it has made a representation about the size of the losses, subsequent events have shown the losses were significantly greater.

Now, the Spanish government is turning to third parties to determine the size of the losses claiming that it does not know the extent of losses.

Had it only been the Spanish government that needed third parties to determine the size of the losses, a case could be made that it is only their bank oversight model that is broken.  The fact is the same bank oversight model did not work in Ireland or Greece either as they too used third parties to find the extent of the losses.

Clearly, the bank oversight model is broken and needs to be replaced.  The question is with what?

Your humble blogger would suggest a return to the original design of the bank oversight model.  Originally, bank regulators were suppose to complement and not replace market oversight.  Recall that in the 1930s it was a sign of a bank that could stand on its own two feet to disclose all its assets and liabilities.

We need to return to this original balance where market participants had access to the same information as bank regulators.  This means ending the current bank regulator information monopoly and requiring banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

With this disclosure, everyone will know the size of the losses in the banking system.

More importantly, this disclosure will end the practice of regulatory forbearance.  As a result, losses will be realized and it will become easier for a creditworthy borrower to get a loan than a zombie borrower kept alive under regulatory forbearance.

The recognition of losses will end the drag on the real economy from supporting the excess debt in the financial system.  As a result, the real economy will return to a positive growth path.

Finally, going forward, with ultra transparency, the bank regulators can tap the market's analytical abilities to help them in oversight of the banks.