Bank of England to call for banks to provide transparency

As reported by the Wall Street Journal, the Bank of England's Financial Policy Committee will call on banks to provide transparency so that market participants can independently assess the value of each bank's assets and each bank's solvency.

Regular readers know that the only way to accomplish this is if the banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

The Bank of England is expected Thursday to heap further pressure on U.K. banks to come clean about the value of their assets, a move aimed at rebuilding investor confidence in the sector and freeing up idle resources to make more loans and foster a stronger economic recovery. 

The central bank's Financial Policy Committee, which brings together regulators, BOE officials and finance industry veterans to assess the health of the financial system, warned in September that banks will find it difficult to attract capital as long as investors are unsure of precisely how much bank assets are worth. 

The issue is also causing a headache for regulators--who say the banks' opaque balance sheets mean they can't decide whether lenders are safe or not--and for rate-setters steering U.K. monetary policy....

Please re-read the highlighted text as it appears that your humble blogger's argument for requiring the banks to provide ultra transparency has been both heard and understood.

"Capital needs could be better clarified, and the task of attracting fresh capital facilitated, if steps were taken to reduce uncertainty about valuations of on-balance sheet assets," the committee concluded, according to a record of its September policy meeting. 

Participants noted "market doubts" about the price tags banks currently place on some of their loans and other holdings, and vowed to consider how to tackle the issue this month after assessing the latest data....

Everyone knows that the price tags are wrong because of suspension of mark to market accounting and the adoption of regulatory forbearance that allowed banks to engage in extend and pretend with their bad debt.

Outgoing BOE Governor Mervyn King ... told lawmakers Tuesday there are "fundamental questions" that need to be addressed over whether banks' published balance sheets truly reflect their real-life positions.

 This can only be answered if the banks provide ultra transparency.

BOE officials and bank supervisors at the Financial Services Authority fret that, cheap funds or not, one reason some banks may be unwilling or unable to lend is that their balance sheets may be clogged with bad loans. 

Rather than foreclose and take losses, lenders have instead tweaked loan conditions or given borrowers more time to pay up, tying up capital that could be used to fund loans elsewhere. 

As far back as June last year, the central bank was warning that while such "forbearance" provides a lifeline to struggling homeowners and businesses and can, therefore, enhance financial stability, banks were nonetheless unsettling investors by failing to make adequate provisions for any potential losses.

Meanwhile, officials on the BOE's Monetary Policy Committee, which sets interest rates, worry that banking sector problems mean capital may be stuck in unproductive industries and isn't being shifted to the productive bits of the economy where it is sorely needed, a phenomenon that is severely impairing growth. 

British policy makers are desperate to ensure that the country doesn't succumb to a "lost decade" of stagnation like Japan did in the 1990s. Japanese banks' unwillingness to recognize losses--an endless "evergreening" of bad loans to "zombie" companies that the authorities took too long to tackle--has been identified as one of the key factors that kept Japan's economy in stasis.

 Regular readers have seen this argument presented on this blog in too many posts to count.

Richard Barwell, an economist at Royal Bank of Scotland and a former BOE official, believes policy makers are poised to act. He anticipates the FPC will Thursday set out fresh guidance on how best to ensure banks are valuing their assets prudently. 

"It is hard for investors to be sure which banks are weak and which are strong, and which if any need more capital, given the lack of consistent information. It all boils down to whether there is a difference between how the banks are valuing their assets and what they are really worth."

 And the only way to solve the question that has dogged the banking industry since the beginning of the financial crisis is if each bank provides ultra transparency.

To be sure, demanding banks open up about the true state of their balance sheets is fraught with risk. It may expose banks dangerously short of capital, potentially a big problem when two--Royal Bank of Scotland Group PLC (RBS) and Lloyds Banking Group PLC (LYG)--are largely in the hands of the taxpayer. It could also force banks to call in souring loans, leading to a surge in foreclosures and economic hardship. But policy makers hope that confronting an issue that has been festering since the crisis started may also allow the U.K. economy to finally get back on its feet.

I hope that I have answered the question of capital (not to worry as bank are designed with deposit insurance and access to central bank funding to operate with low or negative book capital levels).

I hope I have also handled the issue under the Swedish Model of banks recognizing their losses upfront.  As Iceland showed, banks can recognize their losses without throwing families out of their houses.