Head of UK bank regulator: "banks' assets wrongly valued"

The Telegraph reports that the newly appointed head of the Bank of England's bank supervision area says that banks are not valuing their assets correctly.

That banks are not valuing their assets correctly is not news.  Your humble blogger has been talking about this since the beginning of the financial crisis and the adoption of regulatory forbearance (which turns non-performing loans into 'zombie' loans the banks claim are performing) and the suspension of mark to market accounting (which lets bank management mark their securities to mythology).

What is newsworthy about the statement is that the regulator wants to end these deceptive practices and have the assets actually properly valued.

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

With this information, the market can an will value the assets.

This has several advantages including:

1. Markets are designed to price assets so the price of the assets reflects not just the regulators' or bankers' opinions; and
2. Markets are not influenced by the lobbying of the banks for higher asset valuations;

With this information, the market will also exert discipline on the banks so that any losses that are currently being hidden on or off the banks' balance sheets are recognized.

The new PRA, which will be a division of the Bank of England, will take over the prudential operations of the FSA – ensuring banks hold enough capital and liquidity to withstand shocks unaided. 

It is intended to be the first line of defence in preventing the UK’s largest banks from ever returning to the point they reached four years ago, when their failure threatened to bring down the entire financial system.

The new PRA should use the market as leverage to fulfill its role as the first line of defense in preventing UK banks from threatening to bring down the entire financial system.

PRA can easily do this by championing requiring the banks to provide ultra transparency.

With this information, the PRA can access the market's ability to analyze data to identify banks that have a higher risk profile.

With this information, the PRA can piggyback on the market's ability to exert discipline on these banks to reduce their risk profile.

Among the body's first tasks will be an assessment of the risks being taken by large banks. 

An assessment that the market and its experts is more qualified to perform than the PRA and its staff.

Mr Bailey told The Times there was a need to "bring this capital debate to a head and ask what is it we are concerned about". 

He added that regulators believed there were still problems with bank balance sheets: 

“Some assets are valued in a way I don’t think is sufficiently prudent. That is not lying. That’s a matter of judgment.”

In matters of judgment like asset valuation, it is better to have an independent third party value the assets than the regulators or the bankers.  That independent third party is the market.

The Cambridge-educated economist cautioned that banks remained too big to fail.

A problem that requiring the banks to provide ultra transparency cures as the market exerts discipline on these banks to reduce their risk profile.

He believed too that the industry faces a small “tail risk” that fines over Libor, mis-sold interest rate hedging products and other wrongdoing could cause institutions to “keel over”.

Banks are not like non-financial firms.  They don't keel over.  They only go out of business when the regulators close them down.

Banks are designed to operate with low or negative book capital levels.  They can do this because of the combination of deposit insurance and access to central bank funding.  Deposit insurance effectively makes the taxpayers the banks' silent equity partner when they have low or negative book capital levels.

Mr Bailey will also become the third deputy governor of the Bank of England. In his role as one of the three deputy governors of the Bank, Mr Bailey will have responsibility for prudential regulation. He will also become a member of the Court of Directors (the governing board of the Bank) and a member of the Financial Policy Committee.