Monday, July 30, 2012

French regulator: most post-crisis measures are justified

In an IFLR interview, Edouard Vieillefond, a managing director of France's financial regulator, asserted that taken individually, most post-crisis measures are justified.

A defense of the regulatory response to the financial crisis is exactly what should be expected from the Financial-Academic-Regulatory Complex (FARC) as their response exacerbated the financial crisis and has done almost nothing to prevent the next crisis.

One of the key pillars of the regulatory response has been to require banks to achieve a much higher level of capitalization.  For example, EU banks had to reach a 9% Tier I capital ratio by the end of last month.

The result of this drive for higher capital levels has been two-fold: retention of zombie loans on bank balance sheets and an EU-wide credit crunch for creditworthy borrowers.

Together, these have had a major negative impact on the real economy.  Supporting zombie loans siphons capital out of the real economy that is needed for reinvesting in the real economy.  The credit crunch for creditworthy borrowers crushes growth in the real economy.

Equally importantly, the focus on higher capital levels is completely misplaced as a modern banking system is designed so that banks can protect the real economy by absorbing the losses in the financial system.  Banks can do this because with deposit insurance and access to central bank funding banks can operate for years with negative book capital levels.

Regular readers know that the regulatory response by FARC was designed to protect FARC and not to actually address the causes of the underlying financial crisis.  As a result, the French regulator is out trying to defend the indefensible.

We had a crisis that resulted from opacity in the financial system.  Specifically, opacity that prevented market participants from having access to all the useful, relevant information in an appropriate, timely manner.

Examples of this type of opacity are banks (think BoE's Andrew Haldane's "black boxes") and structured finance securities (think your humble blogger's "brown paper bags").

None of the regulatory responses address this type of opacity as doing so would greatly reduce the need for financial regulations.

When it comes to influencing the direction of regulatory reform in Europe, France has a leading role. Indeed, the Autorité des Marchés Financiers (AMF) identified the problems posed by money market funds (MMFs) and exchange traded funds (ETFs) long before they became key issues on the international agenda.   
And France is now witnessing a unique phase in global economic history. Banks are scrambling to meet new recapitalisation requirements imposed to stave off another financial crisis, the eurozone is entrenched in a debt crisis and, with the seemingly unstoppable rise of the Chinese super-power in the east, the world economic order looks set to change dramatically.  
Against a backdrop of so much uncertainty, IFLR took the opportunity to speak with Edouard Vieillefond, the managing director in charge of the regulatory policy and international affairs division of the French regulator. It was a chance for Vieillefond to set the record straight on the views of the AMF, one of the key players on the international stage at this crucial juncture.... 
the French regulator discusses everything from the huge changes in financing economy and what he has learnt from the eurozone crisis, to whether he worries about unintended consequences of regulation. 
Most European banks are on course to implement Basel III ahead of schedule. Do you think we run this risk of going overboard with financial regulation? 
The consequences of Basel III will be crucial for everyone. It will mean big changes in the way the European economy is financed. Sometimes there are complaints about the unintended consequences of regulation. We should be reasonable: taken individually, most of the post-crisis measures such as Basel III are justified.
They are only justified if they address a cause of the financial crisis and not a symptom.
Let’s remember what happened and the reasons why we are asking for more capital and more liquidity. There wasn’t enough capital, probably not enough liquidity and there was insufficient collateral in transactions.
Lack of capital and liquidity were symptoms of the problem.  The problem was opacity.  With opacity, market participants cannot tell if the banks have adequate capital and/or liquidity.
Today banks have two constraints: capital and liquidity. In future, they will have three, with collateral soon to be added to the list thanks to rules such as Emir [the European market infrastructure regulation].
 This doesn't address the opacity problem.  In fact, as discussed above, it only makes the situation worse.
But we probably need to be mindful at the cumulative consequences of all regulations and take into account the overall regional effect of MiFID II [markets in financial instruments directive], Emir, Basel III, and Solvency II for the insurance sector. 
Banks should avoid deleveraging at the expense of the economy. Instead, they should seek where possible to use other tools to reinforce their capital. According to the European Banking Authority (EBA), around 80% of bank restructuring in Europe is carried out not through deleveraging but through the addition of more capital, the transformation of hybrid products into equity, selling non-strategic assets and so on.
As your humble blogger predicted, so long as bank balance sheets are opaque black boxes, there is no one who is going to want to invest in the banks. There is no way to assess the risk of the bank.  You cannot trust what the financial regulators say (just look at how many banks have had to be nationalized after passing stress tests).

As a result, buying equity in a bank is not investing, but rather blindly betting.

With no investors, it was easily predictable (I did) that the banks would not avoid deleveraging at the expense of the real economy.  In fact, what banks have done in the pursuit of higher capital ratios has been devastating to the real economy.
We need to find the right balance between risk and reward and keep in mind that the financing of the economy will shift to equities and long-term products. We therefore need to keep investors interested in buying equities and bonds. That is especially important since more activity will happen through markets than before because there will be less bank financing
I can understand why the large banks with investment banking operations would want to grow the EU bond market.

However, it is the market for the debt of small businesses and individuals that needs to be restarted.  This is a market that is only coming back when there is transparency.  Transparency that results from observable event based reporting.  With observable event based reporting, all activities like payments involving the collateral backing the security are reported to market participants before the beginning of the next business day.

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