Friday, October 19, 2012

Report says regulators should have stopped RBS from buying ABN Amro

In a classic case of missing the elephant in the room, the UK Treasury select committee said that regulators should have stopped RBS from completing the ABN Amro acquisition.

Excuse me, but shouldn't the regulators have stopped RBS from taking on all the toxic securities and bad debt that wasn't related to ABN Amro?

One reason your humble blogger has been advocating requiring banks to provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details is to bring market and not just regulatory discipline to restraining bank risk taking.

It is far from clear that the regulators understood just how risky RBS was before the ABN Amro acquisition.

However, it is perfectly clear that the market did not understand how risky RBS was.

If RBS and ABN Amro had been required to provide ultra transparency, the market would have restrained the risk of both organizations.  Even if the merger occurred, both companies would have had dramatically less risk.

The Financial Services Authority could and should have intervened to block Royal Bank of Scotland taking over Dutch bank ABN Amro, the Treasury select committee has said, in a report that makes a "serious indictment" of the former management of the City regulator. 
The £49bn deal is one of the factors that led to the £45bn taxpayer bailout of RBS in October 2008, because it squeezed the bank's capital buffers to wafer-thin levels and exposed it to more troubled loans. 
In the committee's response to last year's FSA report into the collapse of RBS, Andrew Tyrie, its Conservative chairman, called for the new Prudential Regulation Authority being spun out of the FSA to be given powers to approve major mergers and acquisitions. 
Hostile takeovers might also need to be banned, he said. 
"There are early, encouraging signs that, in the PRA, judgment-based regulation is doing more of the heavy lifting than the FSA's failed culture of box-ticking," said Tyrie....
One might question the judgment of the PRA as it has not insisted that the banks be required to provide ultra transparency.

Who is likely to be better at identifying potential problems:  the market (with investors and banking competitors) or the regulators?

Clearly the market has a lot more money and expertise that it can bring to assessing the banks if it is provided with ultra transparency.
The committee said that the FSA's report painted a picture of a "severely unbalanced regulator" and that even though the international mood at the time was in favour of a "light touch" approach, the regulator's management should have done more.... 
The FSA said it had "put in place a completely new model of supervision since the financial crisis in addition to major changes to the capital and liquidity levels firms are required to hold"....
It needs a further nudge or two and a recognition by regulators that their job is not just to make sure things look pretty in the regulatory garden and go off for dinner. Their job is to be thinking extremely hard about where the risk really lies in these institutions."
Actually, it is not now and has never been the job of regulators to be thinking extremely hard about where the risk really lies in these institutions.

It is the job of the regulators to make sure that banks provide ultra transparency so that market participants can see and assess the risks that each bank is taking. 

It is the job of the market participants to adjust both the amount and price of their exposures to each bank to reflect its risk and the market participant's ability to absorb losses given this level of risk.

One market participant is the state as a deposit guarantor.  As the risk of a bank increases, so too should the cost of the deposit guarantee.  This can take many forms including higher prices and requiring more equity.

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