The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Tuesday, April 16, 2013

Sweden's economic elite pushing higher bank capital buffers

Regular readers know that your humble blogger has frequently debunked the myth of this easily manipulated, deceptive accounting construct known as bank capital.

My question is what part of this debunking are economists having a hard time understanding so that they stop pushing for higher bank capital requirements?

Paul Volcker says that no one knows what bank capital is. Does that stop the economic elite calling for more bank capital? No.

Sheila Bair says that bank capital is easily manipulated and therefore presents a deceptive picture of a bank's true risk. Does that stop the economic elite calling for more bank capital? No.

The OECD says that bank capital is meaningless because as an accounting construct is is easy for both regulators and banks to manipulate. Does that stop the economic elite calling for more bank capital? No?

Dexia and other banks pass a regulatory stress test focused on capital adequacy with high marks and have to be nationalize shortly thereafter. Does that stop the economic elite calling for more bank capital? No.

George Akerlof won a Nobel Prize in Economics based partially on his work on accounting control fraud in banks. Does that stop the economic elite calling for more bank capital? No.

Financial regulators outside of Iceland did not require the banks to absorb the losses on their bad debt exposures at the beginning of the financial crisis. They were worried that recognition of these losses would trigger bank runs. This calls into question whether financial regulators are capable of requiring banks to absorb losses regardless of bank capital levels. Does that stop the economic elite calling for more bank capital? No.

Banks are designed because of deposit guarantees and access to central bank funding to be able to operate and support the real economy even when they have low or negative book capital levels (see large US banks in mid-1980s when their book capital adjusted for exposure to loans to less developed countries). Does that stop the economic elite calling for more bank capital? No.

The economic elite failed to predict the financial crisis and their policy recommendations since have not ended the financial crisis. Does that stop the economic elite calling for more bank capital? No.

Bank lobbyists understand that higher capital requirements, which the banks will game, is a great tradeoff if banks can retain their current opacity that allows them to gamble with taxpayer money and engage in activities like manipulating the global benchmark interest rates for personal profit. Does that stop the economic elite calling for more bank capital? No.

The best the economic elite can do to defend their call for banks to hold more capital is to trot out the story of the Emperor's New Clothes. A story that even the youngest child knows is about transparency.

Oh, did I say that transparency is a necessary condition for bank capital to be meaningful? No surprise, as transparency is the necessary condition for the invisible hand of the market to operate properly.

Sweden’s economic elite are debating whether governments with oversized bank industries need to demand even tougher capital standards than those agreed after the latest wave of regulatory tightening.

Sweden’s requirement that its four biggest banks set aside at least 10 percent in core Tier 1 capital of risk-weighted assets this year, and a minimum of 12 percent from 2015, marks one of Europe’s most stringent regulatory overhauls.

Yet some of the nation’s most influential economists now argue those rules may be too weak to protect the economy from losses.

“Ideally, the capital requirements for banks should be raised substantially,” Assar Lindbeck, a research fellow at the Research Institute of Industrial Economics, said yesterday in an interview.

Lindbeck is one of the main architects behind Sweden’s budget surplus rule and a former chairman of the Nobel Economics Foundation that selects laureates every October.

He says a capital buffer as high as 20 percent might be called for....

According to Lindbeck, much of the work to protect taxpayers from banking industry risks should be done through stricter capital rules and curbs on investor rewards.

“I can imagine the possibility of putting a stop to dividends for a couple of years to build up capital buffers to between 15 percent and 20 percent,” he said. “That may possibly raise interest rates, but we have to accept that. It’s much worse if we end up with a banking crisis.”...

Banks have so far amassed more capital than the regulatory minimum. Nordea’s core Tier 1 capital ratio reached 13.1 percent of risk-weighted assets at the end of last year, while Swedbank’s was 17.4 percent and SEB’s was 15.1 percent. Svenska Handelsbanken AB (SHBA) had a ratio of 18.4 percent in the final three months of 2012. The results put Sweden’s biggest banks at the top of capital rankings in the EU.

Even those levels may still leave room for losses, given the unstable nature of banking, Lindbeck said.

“The banking business is risky since it lends other people’s money and you then need a sizable buffer,” Lindbeck said. “It’s a misconstruction in the world’s banking system that they’re working with so little capital.”

It is a misconstruction that banks are allowed to operate behind a veil of opacity so that market participants cannot see the risks they are taking and act to restrain these risk.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.