© Elliott R. Morss All Rights Reserved
In my last article, I argued that the Middle East, India, and the Eurozone were the most dangerous regions in the world. In this piece, I argue that the Bank for International Settlements is the most dangerous institution in the world. I also provide a listing of US banks that gambled with depositors' money before the banking collapse that are still not "out of the woods."
Bank for International Settlements
According to its mission statement, the Bank for International Settlements (BIS) is "to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks." This all sounds quite reasonable and good. So why is BIS so dangerous? It is the most dangerous institution in the world because through its "Basel Accords", people are led to believe banks' "gambling" with depositors' funds can be safely regulated. This is nonsense. Banks cannot be effectively regulated even with the three Basel accords. The only solution? Don't allow depository institutions to:
- Sell the loans they make, and
- Engage in any proprietary trading
To understand why, read on.
The ABCs of Banking Regulations
Banks take in cash as deposits. They are required to keep something less than 10% of these on hand to cover the normal fluctuations between new deposits and withdrawals. The rest of their deposits (90%+) remain for bank investments. Banks are supposed to cover most of their costs via the "spread" - the difference between what they earn on their investments and what they have to pay to attract deposits. At least that is how it used to be.
In the past, banks knew their very survival depended on the safety of their investments (mostly loans to businesses and mortgages). As a consequence, they took great care to make sure they made safe investments. Any old time banker will tell you the bank staff spent a good deal of time making sure their borrowers were OK and helping them in any way they could.
In recent years, banks have increasingly "bundled" their investments and sold them off for commissions. Note what this does to the internal incentive structures of banks. Instead of having their very existence depending on the safety of their investments, generating commission income gets top priority. So how can banks maximize commission income? By making as many loans as they can and selling them off. So what then happens to banks' concern over the safety of their loans? It disappears: just make as many loans as possible and sell them off for commissions.
Enter the Basel Accords
The Basel Accords are an attempt to regulate bank safety by providing different "safety weights" to bank assets. Even though there are now 3 Accords, their essence is encapsulated in the 1988 Basel I Accord. Basel I creates a bank asset classification system. This classification system groups a bank's assets into five risk categories:
- 0% (no risk) - cash, central bank and government debt and any OECD government debt;
- 0%, 10%, 20% or 50% - public sector debt;
- 20% - development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank debt (under one-year maturity) and non-OECD public sector debt, cash in collection;
- 50% - residential mortgage packages/derivatives;
- 100% - private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and equipment, capital instruments issued at other banks.
These weights are applied to a bank's assets. Their total is called a bank's risk-weighted assets (RWA). Banks must maintain capital (cash or near-cash) on hand equal to at least 8% of its risk-weighted assets. For example, if a bank has risk-weighted assets of $100 million, it is required to maintain capital of at least $8 million.
Devil in Details
So let's consider the concrete example. In Table 1, less and more risky cases are presented. In both cases, "safe" investments (Cash and Treasuries) get 0 weights; less safe investments (mortgages) get 50% weights. With more invested in mortgages, the RWA increases and the ratio falls.
Table 1. - Example of Basel I
Basel I was in place in 1988. It did not help. Suddenly, there was no market for mortgages, mortgage packages or mortgage derivatives. A 50% risk discount was not enough. Based on what happened, the risk discount for mortgages should have been 100%!
And consider the European banking collapse that followed. According to Basel I, OECD government debt (including Greek debt) got a 0% risk discount: it was considered to be as safe as cash! Absolutely no risk discount for holding Greek debt!
When the US and European banking collapses hit, BIS rolls out the Basel III Accord. This calls for significantly higher requirements for loss absorption, puts greater emphasis on a higher quality of capital, and is supposed to better capture the full scope of bank risk. In addition, it includes a leverage ratio, a capital overlay for systemically important banks, a countercyclical capital buffer and standards for a liquidity coverage ratio (LCR). And the Financial Institution Asset Value Correlation (FI AVC) was amended to increase the RWAs for banks' exposures to large and/or unregulated financial institutions.
Does this sound impressive? It is a lot of gibberish nonsense. The real problem with the Basel Accords? Someone has to determine risk weights. And in the case of the banking collapses the world is trying to recover from, BIS risk determinations for mortgage packages and Greek debt were dead wrong.
And how about the recent $6.2 billion JPMorgan Chase (JPM) loss? It came out of the blue! Where were the regulators? Where was Morgan supervision?
A Case in Point - Trying To Regulate Citibank
Suppose your assignment as a bank regulator is to supervise Citibank (C). Citibank has been busy: already in 2013, it has made 504 filings with the SEC. Go to Citi's latest quarterly report (8-K). There you will find that at the end of 2012, its "Investments at Fair Value" were $294 billion. The footnote to this entry reads: "this element represents the portion of the balance sheet assertion valued at fair value by the entity whether such amount is presented as a separate caption or as a parenthetical disclosure. Additionally, this element may be used in connection with the fair value disclosures required in the footnote disclosures to the financial statements. The element may be used in both the balance sheet and disclosure in the same submission. This item represents investment securities as of the balance sheet date which may include marketable securities, derivative financial instruments, and investments accounted for under the equity method." Bank regulators are human beings like you and me. They have to understand this stuff?
There is also an entry there you can click on to "View Excel Documents." You will get an Excel file containing the company's financial statements. The file includes more than 130 separate sheets of detailed financial information. Aside from making risk judgments, Citibank and many other banks are far too complex to be effectively regulated.
Banks That Gambled with Depositors' Money and Lost
In earlier articles, I have covered banks that got TARP bailouts and had not yet paid the Treasury back. Even now, 5 years out, 137 banks have failed to repay. This is expensive money. Treasury is now charging 9%. What about banks that have still not repaid? Draw your own conclusions.
In Table 2, I list the 20 banks that have paid back the smallest portion of their TARP bailout monies.
Table 2. - 20 Banks That Have Paid Back Smallest Percent of TARP Support
Source: TARP Report, August 26, 2013
Table 3 lists the top 20 banks in terms of TARP obligations.
Table 3. - 20 Banks That Have Largest Outstanding TARP Obligations
Source: TARP Report, August 26, 2013
Why Banks Are Fighting Against Any Limits On What They Can Do
Senior bank officials want to make a lot of money, and they can't justify their pay-checks if they can't take big risks. Taking risks are a win-win proposition for bank executives. If they guess right, they make a lot of money and justify their salaries. If they guess wrong, governments bail them out. Have any of the big bank presidents lost their jobs as a result of the banking collapse in 2008? No.
After the recent Morgan loss referenced above, Senator Merkley suggested to JPMorgan President Dimon: "If you want to be the head of a hedge fund, be a hedge fund…. Terminate your access to the Fed's discount window, terminate your access to deposits, and then we have no quarrel." Fine with me.
Bank gambling with depositors' money cannot be effectively managed. The Basel Accords are a joke. What to do? Don't allow depository institutions to gamble. How? As I have been arguing since 2009, limit government deposit insurance to banks that hold the loans they make to maturity and do not trade on their own account. Does this sound like the 1933 Glass-Steagall Act? It does. The authors of that bill were right: trading is too dangerous for depository institutions.