Sunday, March 10, 2013

Head of Parliament's banking standards commission say UK's bank reform bill "wholly inadequate"

To no one's surprise given what is in the bank reform bill currently before Parliament, the head of the Commission on Banking Standards, MP Andrew Tyrie, called it "wholly inadequate".

As reported by the Guardian, Mr. Tyrie was not pleased with either the bill's proposed implementation of a ring-fence between investment and commercial banking or the bill's proposed leverage ratio to limit the risks banks can take.

What makes both of these wholly inadequate is that ring-fencing and leverage ratios substitute complex rules and regulatory oversight for the combination of transparency and market discipline.

Our current financial crisis shows that the combination of complex rules and regulatory oversight doesn't prevent a bank solvency led financial crisis from occurring.  More importantly, had all the additional complex rules and regulatory oversight been in place, it still wouldn't have prevented the financial crisis from occurring.

The combination doesn't work for a simple reason:  the job of financial regulators is to protect the sovereign from making payments on its deposit guarantee.

By choice, financial regulators do not protect the sovereign by approving or disapproving of every exposure that a banks takes.  If financial regulators did so, they would be responsible for determining where capital is allocated across the real economy.

Rather, financial regulators try to assess the risk of each bank's exposures and determine if the bank has enough capital to absorb the expected losses on these exposures without relying on the taxpayers.

Compare and contrast this with how the combination of transparency and market discipline works.

When investors in unsecured debt and equity have access to all the information they need to assess the risk of each bank, they are responsible for any losses on their investments.  As a result, they have an incentive to use the information on a bank's current global asset, liability and off-balance sheet exposure details.

Effectively, investors approve or disapprove of every exposure.  This makes sense as they have a much lower tolerance for loss than financial regulators have (investors are in a first loss position and the taxpayers are in a second loss position).

A key plank of the chancellor's plans to reform Britain's banks in the wake of the financial crisis and the Libor rate-fixing scandal is "wholly inadequate", MPs have warned as they reopened the debate on breaking up the banks. 
The parliamentary commission on banking standards said the government's proposal for the regulator, the Financial Policy Committee (FPC), to review the strength of the ringfence between high street and riskier investment banks was little more than the regulator "marking its own examination paper". 
It said the government should include a specific provision to consider a full, industry-wide split-up of the banks if the ringfence was judged to be failing.... 
Tyrie said the bill was "certainly much improved". "However, the government rejected a number of important recommendations. The commission has examined these again, alongside the government's explanations for rejecting them. 
"We have concluded that the government's arguments are insubstantial. There remains much more work to be done to improve the bill." 
The commission also called for limits on the risks banks take through what is known as the leverage ratio. The government has set it at 3% – allowing banks to borrow against their capital 33 times – while Sir John Vickers in the report by his Independent Commission on Banking had called for 4%.... 
It is highly regrettable that the government appears to be compressing the timetable and railroading the bill through committee stage," Tyrie said. "The task of sorting out the banking industry, of which this Bill will form a major part, is absolutely essential for the long-term health of the British economy. Let's get it right."

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