On the eve of the US Senate passing “the most comprehensive financial regulation reforms we have seen since the 1930s”, in the words of US Ambassador and ex-banker Louis Susman, and the European Council’s meeting to update its progress on a reform package for the supervision of the European financial system, it is no wonder that the British Bankers’ Association (BBA) International Conference on 13 July 2010 in London focused mainly on impending regulatory changes.
The predominant discussions were around remuneration, bank taxes and levies, Basel III and Capital Requirements Directive (CRD) III and IV, and, of course, the ‘too big to fail’ debate resurfaced again this year.
The title of the conference was the question: evolution or revolution? Angela Knight, chief executive officer (CEO) of the BBA, was quite clear in her opening speech that evolution was the way forward for the industry. “Many changes have already been made. What happens next, though, will affect many parts – our functions, our operating costs, and the supply and price of credit to the economy,” she said. “We therefore need a sensible, well thought-out evolutionary process from where we are to where we need to be, undertaken in co-ordination with our policy makers.”
On all issues, the big push from the banking industry is for a co-ordinated global-level response that would tie all countries into a relatively uniform roll out of financial reforms in order to protect competition. But that is looking less and less likely.
As Knight said: “The G20 began well in pulling these initiatives together. But what looked coherent some 18 months ago looks much less so today. It is one of the tasks of the BBA to engage not just with the UK reform agenda but the EU agenda and those of the international standard setters.”
Stephen Green, group chairman, HSBC, also weighed into this debate, highlighting the possibility of an arbitrage effect if regulations are implemented unevenly across the globe. “The European Parliament’s proposal on remuneration is a very clear example that raises questions about international co-ordination. It is a broadly sensible proposal, although aspects of it are still unclear. But if very different regulations prevail in the US, Switzerland and Asia, for example, then it risks providing real incentives for a mobile population to arbitrage the rules to London’s – and therefore the UK’s – disadvantage.
“Then there is the question of taxes and levies. The current array of proposals is striking in its lack of consistency in terms of amounts, duration, basis of calculation and ostensible purposes. In the absence of global co-ordination, banks face distortions and could end up facing overlapping national and regional requirements that could result in double taxation,” he added.
President and chief executive officer (CEO) of Royal Bank of Canada, Gordon Nixon, opened his speech by describing why Canadian banks have proven to be more resilient during the financial crisis, while attempting to dispel the myth that it was the conservative, boring nature of Canada’s banks.
He argued that proper risk capital allocation against trading businesses would automatically restrict higher risk activities and at same time allow banks to make their own decisions around business strategy and capital allocation – but that Basel III is not the way forward.
“Basel III’s proposed rules are supposed to be a starting point for discussion. Ironically, these proposed rules, for all their good intentions, will negatively impact even the healthiest bank’s balance sheets in terms of capital, leverage ratios and liquidity and compromise economic growth. The proposals are so complex and onerous that we run the risk of an agreement that lacks transparency and integrity, or one that results in non-uniform implementation,” said Nixon. “Canadian banks, as an example, would be lifted from their position as well-capitalised, liquid financial institutions and recast as undercapitalised. Banks that passed the ‘real life’ stress test may fail the theoretical one – a pretty good indication of flawed methodology.”
The ‘too big to fail’ debate was tackled by Andrew Bailey, executive director for banking services and chief cashier at the Bank of England (BoE). “As the recent record shows, large banks currently cannot safely be put into insolvency and so public money has had to be used ahead of losses being absorbed by so-called capital instruments. That is wrong,” he said. “This brings us to the issue of whether banks should be restructured to facilitate the end of the too big/important to fail issue.”
He argued for a significantly different method to resolve the issue, one based on the London Approach where a debt restructuring is undertaken for a non-bank company. Typically, creditors agree to restructure the debt of the company on the basis that it offers better value than an insolvency, but this can take weeks or months and much haggling. “The reason I mention the elapsed time is that with a non-bank that is possible – the creditors usually cannot run. But, of course, with a bank this is not possible. A loss of confidence in the bank causes the creditors to run very quickly. So with banks everything has to happen very quickly, over no more than a weekend. I call it speed M&A – and it is not good for the nerves,” he said.
The non-bank solution has the advantage of being a market solution, according to Bailey. The idea for bailing in banks, or creditor re-capitalisation, seeks to achieve bank recapitalisation using speeded up non-bank tools. “We need something to give us a credible chance of covering the losses and most likely recapitalising a big bank. Such an event should avoid the use of public money. The idea is that the whole of the capital structure could be written down if necessary, and beyond that it would be possible either to haircut a portion of unsecured creditors, or carry out a partial debt equity swap. It sounds radical, but it isn’t in the non-bank world,” he said.
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