THIS week in Singapore, fresh from the G20 meetings in Brisbane, Bank of England
governor Mark Carney delivered a major speech outlining the future of financial
reform.
As current chairman of the Financial Stability Board (FSB), tasked with coordinating
global financial stability efforts, he patted himself on the back that the Brisbane
meeting had completed the monumental task of designing a post-crisis system of
prudential regulation. The tough job ahead is implementation.
Congratulations – seven years after the failure of Lehmans, the world’s hard working
central banks and regulators have finally agreed on a set of regulations that may
solve the last crisis, but may not solve the next one.
I must say that in carefully reading Governor Carney’s speech, I felt rather staggered
that he can declare that the global financial system is (not will be) safer, simpler and
fairer, when the facts are pointing in the other direction.
Is it safer?
On the adequacy of bank capital, he pointed out that the capital shortfall was much
smaller at £15bil at the end of 2013, compared with £150bil two years ago. The
European Commission (EC) Financial Stability and Integration Report (April 2014),
reported that between 2008 and June 2013, 400 billion euros out of the total
European bank capital increase of 630 billion euros corresponded to increases in
interbank positions and only 230 billion euros represent fresh capital injected from
outside the banking system.
Don’t forget that the banks were fined over US$150bil for misdeeds, half of which
was for breaking sanctions, which was more for geo-political reasons than for putting
depositors’ money at risk.
On Oct 15, while the central bankers were busy in Washington DC attending the IMF
annual meetings, the US Treasury market had a heart seizure that was mostly missed
by the main headlines. The yield on the 10-year Treasury note moved 0.37
percentage points from peak to trough in about 30 minutes, equivalent to “flash
crash” in the bond market.
No one has publicly explained what caused the sharp move, but it was probably a
combination of regulations that restricted the ability of bond market makers to take a
position when the market moves and the simultaneous high-speed trading on
computer algorithms that triggered automatic sell signals that created the “crowded
exit”.
When the markets panic, liquidity disappears. It is not safer, even in the most liquid of
markets.
Is it simpler?
I cannot see how the financial system is simpler when the regulations and trading
models are so complex that you need either an expert lawyer and a PhD in quantum
physics to decipher what is going on. The above EC report suggested that
interconnectedness across banks are so high that as of December 2013 “the
counterparty for 24 per cent of eurozone banking assets (or 7.4 trillion euros) is
another eurozone bank”.
Furthermore, as a result of bank consolidations, the concentration of the top banks in
the world is increasing rather than decreasing.
Is it fairer?
The FSB proudly announced that the Brisbane agreement on Total Loss Absorbing
Capacity (TLAC) for globally systemic banks will result in these banks being resolved
in the future without recourse to the taxpayer and without jeopardising financial
stability. Basically, the TLAC proposes that banks should issue “coco” bonds that will
convert into equity – “bail in” the bondholders when the bank fails.
As risk manager Avinash Persaud (www.piie.com/publications/pb/pb14-23.pdf)
convincingly argues, these “bail-in bonds” are fool’s gold. Once you tie a future failing
globally significant bank to the bond market, and if the bond market also cracks up,
guess who will have to come to the rescue?
The financial system as a whole has not been fair since the central banks started
introducing interest rates below the inflation rate. Guess who has been subsidizing
the large, concentrated borrowers? The pensioners, the small savers and those who
cannot afford to buy speculative assets on leverage.
Guess who has been bailing out the speculative and leveraged players with massive
injections of liquidity and lowered interest rates until they reached nearly zero? The
top four central banks which tripled their balance sheets to US$10 trillion between
2008 and 2014. I was truly disappointed that in a major speech by a major financial
leader on the future of financial reform, the game-changing words that concern us all
– “social inequality”, “climate change” and “technology” did not appear at all. Instead,
the solutions to building a stronger financial sector “that can deliver strong,
sustainable and balanced growth for all economies” were diversity, trust and
openness.
Is diversity being created if we are concentrating derivative financial transactions into
central clearing platforms? Is diversity being encouraged when similar prudential and
liquidity rules are being applied to investors? Can trust be generated when there is
essentially very little trust between bankers who fear changes in the rules one day
and being fined by bankers and regulators the next? Are we being more open when
new regulations make the system more “Balkanized?”
With all due respect, the FSB has put the cart before the horse.
The world economy is like a horse (the real economy) and the cart (financial system)
working together. We had a financial crisis because the horse was overleveraged
and the cart was also overleveraged, with a driver punch drunk on more debt being
the cure-all. When the cart breaks down, it is understandable that we try to fix the
cart. But seven years later, the horse is not only weaker, but even more leveraged
than before. But the driver insists that the cart becomes a Rolls Royce, with more
capital, more robust and safe, trustworthy and open.
But it is the real sector horse, the engine of growth that needs more capital, not more
debt. If the horse falters, the cart will also keel over, irrespective of the increases in
capital and liquidity. The major reason why financial markets are at record highs in
price and turnover, despite serious problems in the real economy, is unconventional
monetary policy.
As a former central banker, I am more used to central bankers who are financial
market referees rather than players. We can all understand that when the game gets
wild, central bankers must play the role of goal keepers, but I do find it strange that
central bankers playing forwards to keep the markets bubbling along can also be the
referee determining the market rules.
Under these rules, an own goal is a victory.
Tan Sri Andrew Sheng is a former central banker and financial regulator.
A version of this article appeared in The Star Online, 22 November 2014
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