Regulator's Dilemma News

RD News 8Dec11

Stress test pushes up the Europe-wide deficit from €106bn in Oct to €115bn now.
Germany’s Commerzbank is facing the prospect of nationalisation - must raise €5.3bn of equity to come into line with the 9 per cent core capital ratio that EBA is demanding by June 2012.
German banks’ aggregate capital shortfall, which also includes a €3.2bn gap at Deutsche Bank, jumped from €5.2bn to €13.1bn.

Asset managers are a major source of funding for banks through the shadow banking system. They are dominant sources of demand for non-M2 types of money and serve as source collateral ‘mines’ for the shadow banking system.
Banks receive funding through the re-use of pledged collateral ‘mined’ from asset managers. Accounting for this, the size of the shadow banking system in the U.S. may be up to $25 trillion at year-end 2007 and $18 trillion at year-end 2010, higher than earlier estimates.
In terms of policy, regulators will need to consider the re-use of pledged collateral when defining bank leverage ratios.
Regulatory efforts aimed at altering funding structures need to be complemented. Current approaches are actively pushing banks away from short-term, secured, wholesale funding markets and incentivizing them to issue more deposits and term funding. Unless the supply of preferred assets is addressed by more safe assets (including sovereign bonds), shadow banking will fill the void.
Regulatory proposals, such as Dodd-Frank and Basel III, that are pushing riskier activities outside the banking system (e.g. proprietory desks, hedge funds and OTC derivatives), will increase shadow banking; thus its linkages to traditional banking warrant closer attention.

Debt deflation dynamics:
First stage involves distress selling of assets by the borrowers to reduce their debt.
Stage two affects bank balance sheets that contract when customers are paying off their debt. A general fall in asset prices, signalling the reversal of the asset bubble, creates a further fall in business net worth.
The consequent decline in the profit level cuts back trade volume when households feel less confident about spending and investors worry about the future.
At the macro-level, trade and output falls while unemployment grows, causing more market pessimism. As the public begins to hoard cash, the velocity of circulation slows down further.
This causes a fall in nominal rates, but since inflation may be falling faster, the rise in real rates worsens the debt burden of the borrowers.
The euro zone is in the grip of this depressing state of affairs.
European problem is a twin bank-fiscal bind, in which the governments have to bail out the banks, but their own fiscal debt overhang is now the root of further deflation.

Cutting interest rate by 25 bps to 1%.
Inflation is likely to stay above 2% for several months to come, before declining to below 2%.

ECB announces four non-standard measures to boost bank liquidity and certainty in the money markets. It will:

provide two long term refinancing operations with a maturity of 36 months
increase collateral availability by reducing the rating threshold for certain asset-backed securities
cut the reserve ratio from 2% to 1%
temporarily discontinue the fine-tuning operations carried out on the last day of each maintenance period, which will also help money market activity.

FED Board: Risk-Based Capital Guidelines: Market Risk; Alternatives to Credit Ratings for Debt and Securitization Positions

Alternative standards of creditworthiness must be used in place of credit ratings to determine the capital requirements for certain debt and securitization positions covered by the market risk capital rules.
Proposed creditworthiness standards include:

use of country risk classifications published by the OECD for sovereign positions
company-specific financial information and stock market volatility for corporate debt positions
a supervisory formula for securitization positions.

Average of 60 regulatory changes every working day, a 16% increase over last year.
Regulators around the world announced 14,215 changes in the 12 months to November, up from 12,179 for the same period a year earlier.
Regulatory announcements have been increasing by between 16 and 20% each year since the ‘08 financial crisis.
More than half the regulatory activity of the past two years has come from the US and Canada – reflects more regulators both at the federal and state level and the enormous amount of rule-making of giant Dodd-Frank act.
Richard Reid, ICFR Research Director: ‘highlights again the issues we will have in trying to harmonise and co-ordinate progress on the regulatory agenda across regions…The low weight of regulatory activity in Asia and the Middle East probably reflects the fact that those regions have had a relatively good crisis and that their financial systems are relatively small.’

US banks want regulators to give them more time to liquidate investments in certain private equity funds under the Volcker rule, arguing that without more leeway they will have to hold ‘fire sales.’
The Volcker rule, part of Dodd-Frank Act, greatly restricts the amount banks can invest in hedge and private equity funds.
Banks already have been trying to shrink their private equity portfolios.
For instance, at the end of the third quarter the book value of BofA's private equity investments was $1.8 billion, compared to $4.8 billion a year earlier.
But they fear certain funds with a longer time horizon, such as those tied to real estate, will take longer than the general timeframe of five years laid out in the Volcker rule to sell the assets at decent prices.
‘You are going to have to go out and sell to third parties, who are not banking entities, that are salivating, just waiting for this to happen because all of these interests will be sold at significant discounts’.

Thursday 8 December 2011