Italian bank derivative scandal highlights need for banks to disclose their exposure details

While the financial industry cheerleaders have gathered at Davos to declare that the financial crisis is over, a derivative scandal involving Italy's oldest bank reminds us that the crisis won't end until the global banking system is fixed and this will not occur until banks are required to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

As Zero Hedge put it succinctly,

Naturally, the implication is that after 4 years of endless bailouts and "recovery", nobody has any clue still just what is on Europe's bank balance sheets. 

And the further implication is that if [the Italian bank involved in the derivative scandal] was doing it, everyone else was, of course, doing it, and much more dirty laundry is soon set to be uncovered...

As reported by Reuters,

European Central Bank President Mario Draghi is facing criticism over a scandal involving loss-making derivatives trades made by troubled Italian lender Monte dei Paschi di Siena while he was Italy's central bank governor.... 

Former Economy Minister Giulio Tremonti said in a tweet that it was "stupefying" that in his role as supervisor of Italy's banking system Draghi had failed to discover or prevent the trades, which took place between 2006 and 2009....

Current Economy Minister Vittorio Grilli avoided mentioning Draghi directly but stressed that it was not the government but the central bank that was responsible for bank supervision. 

"It wasn't us that did the controlling," he told reporters. "On the checks, all I will say is that it is the responsibility of the Bank of Italy." 

Underlining the gravity of the crisis, Italian President Giorgio Napolitano said Monte Paschi's latest problems were a "serious issue" but that he had "full confidence in the Bank of Italy." 

On Wednesday the central bank tried to deflect any criticism, saying the nature of the trades had been "kept hidden" and were only recently divulged by new management appointed last year to turn the bank around....

Please re-read the highlighted text again as it nicely summarizes why all banks must provide ultra transparency.

Until banks provide ultra transparency, market participants need to assume that the banks are hiding something.  Otherwise, they would disclose everything.

The deals under scrutiny are the so-called "Alexandria" trade with Japanese bank Nomura, the "Santorini" trade with Deutsche Bank and a derivative called "Nota Italia", with an unspecified bank.... 

Analysts fear eventual losses could be higher and have urged Monte Paschi to come clean on any other potential surprises....

Let me repeat that there is no reason to believe the management of Monte Paschi or any other banks when it says it has come clean unless the bank provides ultra transparency.

The effectiveness of the Bank of Italy's supervision is being increasingly questioned, despite the fact the country's lenders complain it is more stringent than other European regulators in its monitoring of the Italian financial industry. 

"One has to wonder what the Bank of Italy was doing given all the visits they've paid to Monte dei Paschi in recent months," said a source close to the situation. 

"If what they came here to look at was only the information publicly available in the bank's financial statements, they could have done that from Rome."

One of the lessons of the financial crisis is that market participants cannot rely on the financial regulators to provide an accurate assessment of the risk of a bank.  Even if the regulators properly assess the risk, they have concerns about the safety and soundness of the financial system that prevent them from communicating how bad the situation might be.

Requiring the banks to provide ultra transparency ends the dependence of market participants on the financial regulators.

There is a significant benefit to doing this.  Market participants become responsible for all gains and losses on their exposures as the have all the useful, relevant information in an appropriate, timely manner so they can independently assess the risk and solvency of each bank and make a fully informed investment decision.

Translation:  no more moral hazard over bailing out investors who relied on the financial regulators' representations about the solvency of a bank in making their investment decision.