Tuesday, July 2, 2013

WSJ's Francesco Guerrera: Sizing up bank risk is a stab in the dark

In his Wall Street Journal column, Francesco Guerrera looks at how it is impossible for market participants, including investors and depositors, to assess the risk at any bank.

Regular readers know that the only way that market participants will ever be in a position where they can assess the risk of a bank is if the bank discloses its current global asset, liability and off-balance sheet exposure details.

Without this level of ultra transparency, to quote the Bank of England's Andrew Haldane, banks are "black boxes".

So long as market participants cannot assess the risk of any bank, banks are not subject to market discipline.

Instead, financial stability is dependent on financial regulators both correctly assessing the risk of each bank and accurately communicating this risk to market participants.

Our current financial crisis shows that the financial regulators are not up to this task.

By the way, financial regulators should never have been expected to be up to this task.  Built into their concern over the safety and soundness of the financial system, financial regulators have an incentive to present a picture of the banks as less risky than they really are.
How risky do you want your bank investments to be? Don't laugh, it is a serious question.... 
But the issue for investors, regulators and bank executives is whether they can properly monitor the risks large institutions take in the markets. 
This isn't an academic exercise for risk nerds. The inability to assess, and price, trading risks was a significant factor behind the huge losses sustained by banks during the financial crisis. As monetary and economic uncertainties push markets into a new period of turbulence, is the system better prepared? 
It doesn't look that way. 
There are two fundamental deficiencies in the way banks report their stance on risk: transparency and consistency. The result is that it is nearly impossible for an outside observer, be it an investor or a regulator, to compare trading risks across banks. 
Even regulators admit it. 
When the Basel Committee on Banking Supervision, the international group of watchdogs in charge of designing new capital standards, looked at the issue recently, it concluded that, "in general public disclosures did not provide sufficiently granular information to establish conclusively what is driving the differences" among banks' assessments of risk and capital.
Please re-read the highlighted text as here is the Basel Committee on Banking Supervision agreeing with your humble blogger that the only way to truly assess the risk of each bank is if that bank discloses sufficient granular information.

What is sufficient granular information?

Why ultra transparency and the disclosure of a bank's current global asset, liability and off-balance sheet exposure details.

This is the standard for sufficient granular information that has been in place since at least the early 1900s.  After all, a bank that can disclose its current exposure details is a bank that is telling everyone that it can stand on its own two feet.

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