#Banking, Basel, stress tests, the #IMF and the #G20 — return of the state or return to business as usual?
Another week, another set of screaming headlines dominated by Europe….but not the EU. The simultaneous disappointment and relief in the public commentary surrounding these two events over the last seven days demonstrates a serious mis-reading of underlying trends in the policy space. The disappointment is misplaced. While changing the business of model for banking is certainly still a high regulatory priority, the direction of that change is driven by economic reality rather than political rhetoric. The relief is stunning as well; it signals market confidence that European sovereigns (backed by the IMF) will support their banks….not that the banks acquitted themselves well in soft stress tests. Regular readers of The Risk Telescope are not surprised by these outcomes.
Today’s issue takes the events of the last week to look ahead and ask whether we are seeing a mean reversion globally in how international banking standards are set. The headlines suggest a return to business as usual, in which bank lobbyists in Basel guide the normative process. This analysis is superficial. It ignores a more profound shift in global policymaking. It also ignores major political initiatives globally emanating from Asia, which increasingly views the current situation as Act II of the “North Atlantic financial crisis.” The rhetorical similarity to the description of the 1997-98 “East Asian financial crisis” is no accident…and the potential impact on economic and regulatory policy frameworks may be as large.
Specifically, this issue of The Risk Telescope explores the emerging tensions between sovereign and G20 policy priorities, predominantly but not exclusively through the prism of the EU stress tests and the Basel outcomes. The research suggests that profound statist trends to protect domestic banking franchises transcend lobbying activities in favor of “macroprudential” outcomes designed to deliver economic stability (if not growth). The consequences for regulatory policy and asset allocation strategies will be significant if the trend line continues through the autumn. The bottom line is that we have not yet reached a steady state regarding decision-making structures internationally, as Asian economies in particular seek a stronger voice in global policy processes. This will impact the structure of regulatory standards as well.
Receive the rest of this post by Subscribing to the Risk Telescope 
#IMF on stress testing, scenario analysis, #banking, and #economy #risk
As we head into the (hopefully) quiet days of August, it is a good time to reflect on the importance of targeted and fine-tuned scenario analysis. The EU stress tests provide the latest example of how and why this activity cannot be subcontracted to sovereign states despite the groundbreaking advances in transparency associated with that exercise. Today, the IMF weighs in on the debate, with some views on what constitutes appropriately rigorous stress testing.
Leaving aside the obviously unfavorable comparisons between their approach and the approach adopted by the EU (and, last year, the US), the message is clear: risk managers and asset allocators need to adopt a more multivariate and rigorous approach to their scenario analysis that blends regulatory, economic, and political trend analysis. As the IMF notes: “Efforts are underway by national supervisors as well as international organizations involved in financial stability, such as the IMF and the Bank of International Settlements, to develop new risk-modeling techniques and stress test methodologies to better identify the risks that trigger widespread economic and financial instability.”
At BCM International Regulatory Analytics, we are we positioned to help financial institutions and their corporate clients think through how these new approaches affect their business models and their risk profiles across multiple vectors. Our Awareness analysis through The Risk Telescope and confidential, bespoke Analytics research positions senior executives to take a more strategic approach to assessing the cross-border multi-disciplinary risk environment in which they operate using our proprietary research methods.
Decisions on Basel 3 #banking and regulatory capital
The BIS and the Basel Committee board have reached agreement on the direction of new regulatory capital requirements for banks (Basel 3). The text of their decision can be found here. Understanding the text requires a solid understanding of the underlying proposals, the pre-existing Basel 3 framework, and how those proposals will affect the scale and scope of intermediation services going forward.
Subscribers to The Risk Telescope will be receiving analysis of these decisions and the EU stress testing results this week. Clients will be receiving analysis targeted to their areas of interest towards the end of this week as well.
Those interested in subscribing to The Risk Telescope before the new issue is out can fill out the online form available on the “Awareness” section of this website.
#EU #banking stress tests — the good, the bad, and the ugly
Among the many articles written regarding the outcomes of EU stress tests released today, this piece from the New York Times/International Herald Tribune focuses on the implications for the “healthy” banks that passed. It is a good perspective, not because it quotes me, but because it focuses on the important issue of the implications for the European banking sector going forward rather than playing the name game of which sacrificial lambs were permitted to fail.
Beyond the analysis in the article, here are a few more observations on details not yet seen in the early stories covering the stress tests.
The Good: The sovereign bond haircuts were published on a disaggregated basis both by country and by scenario. In addition, banks from several key countries (Italy; France; Spain) specified the distribution of their sovereign bond holdings not only by country but by whether the holdings are in the banking book or the trading book. In addition, the process by which the haircuts were calculated also were disclosed. Finally, the banking book was also stressed. This last point is important given that most EU sovereign bonds are reported held on banks’ banking books (which are not subject to mark-to-market or fair value accounting). Providing insight into the standard country-by-country values used for PDs and LGDs in the banking book under both the baseline and adverse scenarios eliminates a criticism that only part of the bank’s holdings were stressed. Given the general reluctance to publish any bank-specific results prior to today, these disclosures at this level of disaggregation are a step forward for transparency in Europe even if the actual data and assumptions are far too rosy.
The Bad: Not every bank disclosed the distribution of holdings of sovereign bonds, most notably banks in Germany. More importantly, the calculation method for the haircuts and default probabilities leaves much to be desired, to say the least. The sovereign bond haircuts, PDs and LDGs were all based on sovereign CDS spreads as of year-end 2009. That’s right, 2009. Very disappointing. And probably not very realistic of stress levels even today.
The kind interpretation of course is that sovereigns cannot officially and publicly assume the absolute worst. Last year’s US stress tests assumed unemployment rates last year for the adverse scenario that were already outdated when the stress tests were released. So the EU is not alone in generating stress tests with assumptions that seem rosy in comparison with prevailing market conditions at the time the stress tests are released. The difference is that the vast majority of credit intermediation runs through banks in Europe, so the banks are far more important to economic stability and growth there than they are in the United States. The less kind interpretation is that policymakers in Europe reject the signals the market has been sending regarding potential sovereign default and so choose as their starting point a more neutral starting data point (sovereign CDS spreads at end-2009) that is not corrupted by “inappropriate” volatility. Either way, using such outdated data as the basis for calculating haircuts, PDs and LGDs throughout the stress tests invites attempts at reverse engineering based on today’s market conditions.
The Ugly: The EU’s Financial Services Action Plan years ago successfully created a cross-border banking network in Europe focused predominantly on wholesale lending to corporates. Today’s results do not assess the impact that stress on the parent could have on its subsidiaries and affiliates. Also, the results provide no hint of the potential funding stresses in the European banking system embedded within banks’ cross-border networks. IMF and BIS research has made clear this year that failure to assess stresses on funding throughout an organization risks missing key vulnerabilities. This is not a hypothetical situation.
Take Hungary as an example. One of the consequences associated with cessation of the IMF program there is that the Vienna Initiative is in doubt. The Vienna Initiative crafted a cooperative agreement between banks and the official sector in which parent banks agreed to serve as a source of support for their affiliated entities in IMF program countries, regulators agreed to support these initiatives despite the pressure it might put on regulatory frameworks, and the IMF agree to provide liquidity to the program countries. With the IMF program in Hungary currently itself in crisis, real questions arise regarding how banks will continue to serve as sources of support for their affiliates in that country…and thus implicitly provide stability to the overall economy. The IMF statement released yesterday after meeting with bankers and the European Commission indicates that this is no idle worry.
But overall, the release of so much information when many governments sought to avoid such disclosures can only be counted as a success for Europe. Noone really needed these stress tests to tell them that vulnerabilities exist in the European banking arena. These stress tests provide a window into the scope of support the official sector is willing to extent to the banks. Will that create sufficient comfort in the banking sector to stabilize interbank funding rates? We are about to find out.
#Banking, #regulation #reform, capital, and Basel
With the continuing drama in Europe regarding stress tests assumptions, outcomes and disclosures, it is almost easy to forget that major decisions are imminent regarding a key G20 policy priority: changes to the regulatory capital framework for banks. Today’s Businessweek story highlights what is at stake as the BIS and the Basel Committee board prepare to meet next week. The Basel Committee’s interest in obtaining board advice and approval regarding major decisions has increased since the creation of the G20 process. Whether such heightened “corporate governance” procedures generate more solid consensus that delivers consistent cross-border implementation than in the past remains to be seen…and will be a key indicator of the G20′s effectiveness going forward.
New #EU #Banking Stress Test Release Plan
Today, the Committee of European Banking Supervisors (CEBS) announced a new release plan for stress test results. The planned two week delay between release of aggregated results by CEBS (23 July) and bank-specific results by individual regulators and banks (first week of August) has been scrapped. Instead, CEBS will release aggregated results at 1800 hours. Individual regulators and banks have 30 minutes to release specific results. Then, at 1830 hours, CEBS will release specific results with links to individual bank and/or national regulator websites.
The Risk Telescope last week explored in some depth the potential adverse market dynamics that seemed likely to arise from the EU’s planned two-week hiatus between release of aggregated results by CEBS and release of disaggregated results by individual Member States and banks in early August. The new release plan eliminates many of those potential adverse dynamics and focuses attention where it belongs: on the details and rigor of the tests themselves.
Real Stress Tests
In the last 48 hours: i) EU finance ministers met (adding little transparency regarding the stress tests administered by the Committee of European Banking Supervisors (CEBS), ii) the IMF and the Republic of Korea co-hosted a major conference on providing Asia with a greater voice in global economic policy matters, and iii) the Basel Committee prepared to consider new regulatory capital requirements for banks. Some perspective and expectations management are required.
First, some uncomfortable truths. Those seeking clarity from government stress tests on European bank balance sheets will be disappointed. The tests are overseen by the same states that for years have successfully opposed application of fair value accounting to bank assets and liabilities. With banks occupying 73% of credit markets and more than 300% of GDP in Europe, it is easy to understand sovereign motivations to avoid potentially destabilizing outcomes associated with disclosure of large losses on bank balance sheets. They are not alone. Last year’s U.S. stress tests were both optimistic and obsolete by the time they were released. Section One of this report provides a quick comparison of last year’s US stress tests and information that has been made public so far in Europe.
Second, the search for real stress tests continues. Few readers require an official CEBS stress test to tell them what they already know: the European banking sector is weak even before Basel 3 proposals to increase liquidity and tighten definitions of Tier 1 core capital are considered. Section II of this report focuses on alternative scenarios already available in: i) the markets, ii) various official sector reports and statements issued around the edges of the G20 summit last month, and iii) in the re-arrangement of authority and direction of the IMF.
Receive the rest of this post by Subscribing to the Risk Telescope #IMF in #Korea — thinking beyond the #EU #banking crisis
While most of us await the outcomes of yet another meeting of EU finance ministers, half a world away in the Republic of Korea tectonic shifts are underway in the global economic policy process. The IMF today and tomorrow is co-hosting in Korea a conference focused on how the Asian economies can contribute leadership (economic as well as political) and vision to address the economic vulnerabilities of today’s financial markets. Clocking in at 2.5 hours, this link to a video of the opening session at the conference website (www.asia21.org) shows a remarkably free-wheeling discussion among Asia’s economic policy and business leaders in English on the topic of how they see today’s challenges and opportunities affecting their role in the global economy. It is interesting on multiple political levels beyond the substance of economic policy as well. The themes sounded here are consistent with many of the themes I heard recently at the Peterson Institute for International Economics from a senior Korean economic policymaker regarding their priorities for the G20 summit in November at the end of the year.
For a sense of how all this translates into potential scenario and stress test analysis, stay tuned for the next issue of The Risk Telescope, which will be out soon….
