Tuesday, October 2, 2012

A mandate to tackle our banks' failures

In his Financial Times column, Andrew Tyrie, conservative MP and chairman of the Parliamentary Commission on Banking Standards, noted that trust in banks has plummeted and established the goal for the commission of suggesting a remedy that restores trust while also protecting taxpayers from future bailouts and eliminating bad behavior by banks.

Given these goals there is only one remedy.

It appears that Mr. Tyrie's commission will be recommending that UK banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Only ultra transparency restores trust, protects taxpayers from future bailouts and eliminates bad behavior.

Everyone knows that trust is restored when investors can independently assess the risk of each bank.  Investors trust their own analysis and this trust flows through to the banks.

By setting the global standard for disclosure by requiring the UK banks to provide ultra transparency, the UK will gain a competitive advantage for the City.

Ultra transparency protect taxpayers from future bailouts in two ways:

First, ultra transparency provides market participants with the information they need to exert discipline on the banks and restrain their future risk taking.

Second, should an individual bank's management ignore market discipline and cause the bank to fail, the government does not have to bail out the bank because investors/counterparties will have already reduced their exposure to the bank to what they can afford to lose.

Finally, it is only when everything the bank does today is visible and can be front page news tomorrow that standards in banking improve and bad behavior is eliminated.

It is only with this level of disclosure that sunlight can act as the best disinfectant and purge the banking system of its culture of embracing bad behavior.  For example, Libor was manipulated because it wasn't based on observable transactions.
Standards in banking have lapsed. Banks are not serving the real economy as they should and trust in them has plummeted. There has been a culture of recklessness, and often wrongdoing, which has done great damage. This is the well-understood backdrop against which the UK Parliamentary Commission on Banking Standards was created in July. All three main parties are agreed that restoring standards in banking is a priority.

The commission, which I chair, has been asked to conduct pre-legislative scrutiny on the Banking Reform bill by December 18 and we expect to make recommendations early next year – drawing on the lessons of recent financial scandals and on other reports on banking standards. However, our aim is forward-looking; not to launch a retrospective attack on banks or governments. 
This is a global industry with long-standing, global problems, many of which will be familiar to students of banking history. It is also one of the UK’s most important industries and if banks are to be at the heart of our economy, they must be allowed to remain internationally competitive....
It is only ultra transparency that improves the UK banks' international competitive position while also dealing with the long-standing problems in the banking industry.
The problems lie deep, some in the unique features of banking that give it a measure of protection from the full disciplines of the market. 
Specifically the substitution of complex rules and regulatory supervision for transparency.
The implicit government bailout guarantee, a de-facto subsidy of banks held to be too big to fail, protects incumbent banks from competition. Consumers’ reluctance to switch accounts, the lack of price transparency and barriers to new entrants have further compromised competition.... 
Information asymmetries – the gap in knowledge and understanding between banks and their customers – have allowed banks to sell inappropriate products, both in retail and in wholesale markets. Recent scandals have amply illustrated the consequences; a failure of banks, and the culture within banks, to meet acceptable standards.... 
The only solution to information asymmetries is to provide transparency so that the buyer has all the useful, relevant information in an appropriate, timely manner.
Gaps in the law that have allowed banking malpractice to occur require attention. The common perception is that the law has done little to deter practices that often seemed criminal, to victims and observers alike.
 In the case of the US, perception and fact go hand in hand.
Regulation has been shown to be equally defective. A box-ticking culture and pointless data collection are no substitute for effective oversight in both prudential and conduct of business regulation. The claim of the Bank of England’s Andrew Haldane, that more detailed and burdensome regulation has come in inverse proportion to its effectiveness, merits consideration.
Regular readers know that Mr. Haldane effectively argued for requiring banks to provide ultra transparency.  With ultra transparency, much of the detailed, burdensome regulation can be eliminated.  In addition, oversight becomes more effective as the regulator can now tap the market's analytical capabilities for answers.
It is widely held that shareholders have also been absent without leave and that corporate governance requires an overhaul. The formal structures of corporate governance have looked elegant enough in bank company reports but, in a number of cases, we now know that form was a substitute for substance....
The reason that shareholders have been absent without leave is that as a result of current bank disclosure banks resemble, in Andrew Haldane's words, 'black boxes'.  It is hard to exert discipline when you don't know what is happening.
The commission will not be able to address all of these deep-rooted problems in a few months.
Actually, the commission can when it looks at these deep-rooted problems through the prism of ultra transparency.

Looked at this way, it is easy to see the impact of Yves Smith's observation that no one on Wall Street was compensated for developing low margin transparent products.
But we can at least signal some remedies, suggesting ways to protect taxpayers better from the consequences of bank failure and to improve the experience of dealing with banks for customers of all types. If we can manage that, we will have made an important contribution to the task of restoring trust in our banks.
All you have to do is recommend banks provide ultra transparency.

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