Saturday, March 9, 2013

Can regulators really evaluate a Too Big to Fail bank?

Reuters ran an article in response to the results from the latest stress tests in which it explored the question of can regulators really evaluate a Too Big to Fail bank.
The newest stress tests for U.S. banks produced scores that are at odds with other measures of lenders' safety, in another sign that some institutions may be too big for regulators to understand and executives to manage. 
For example, Citigroup Inc, which has been bailed out multiple times by the U.S. government, showed up on the score sheets posted by the Federal Reserve on Thursday as being clearly safer than JPMorgan Chase & Co. 
That conclusion is at odds with the views of investors, bond analysts and credit-rating agencies, as well as when measured by a yardstick regulators themselves want to use in the future. 
"At the end of the day, there is a legitimate question about the ability of regulators to fully evaluate $2 trillion institutions because of the complexity and exposures they have," said Fred Cannon, director of U.S. research at Keefe, Bruyette & Woods.
Which of course raises the question of why the regulators don't require banks to provide ultra transparency so then the regulators can piggy-back off of the analytical work done by the market?

Your humble blogger assumes that, at a minimum, each of the banks is capable of analyzing its own exposure details.  So presumably, each of the banks should be capable of analyzing the exposure details of its competitors.

One of the benefits of providing ultra transparency is that we discover if this assumption is correct.

If it is not, that is okay because market discipline will be exerted on the banks that are too complex to understand to reduce their complexity until their banking competitors and other industry experts can assess them.
On Thursday, the Federal Reserve reported the latest results of the tests that began after the 2007-2009 financial crisis to determine if banks have enough capital to withstand a severe economic crisis. The Fed concluded that the banks are in "a much stronger position" than before the financial crisis in 2008. 
Really?  Where is the disclosure of the supporting exposure details by the banks so that this conclusion can be independently confirmed by market participants?
While experts are not arguing with the fact that the banks are better capitalized now and that the system is safer than it was in the run-up to the financial crisis, some of the numbers the regulators published left analysts and bank executives groping for explanations. 
The test raises questions about the ability of regulators to head off the next big threat to the financial system because of the complexity of the institutions.
Even more reason that the Too Big to Fail should be required to provide ultra transparency.

If a market participant questions the results of the stress test, with the information made available under ultra transparency, they can run the test themselves. 

No comments: