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BFCSA: Bankers and Financiers "greasing the wheel of capitalism" gone mad on TOO BIG TO FAIL BANKS

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Bank earnings drag on recovery - Global connectedness: A world you should start imagining

by Bernard Kellerman | Aug 04, 2014

Renowned Australian-born senior OECD economist, Dr Adrian Blundell-Wignall was in Sydney recently to outline some big-picture views on the state of the world economy. The OECD's director of financial and enterprise affairs, Dr Adrian Blundell-Wignall shared his views on trends and influences affecting the world economy at a luncheon with the Australian Business Economists last week.Blundell-Wignall next moved onto another big picture topic — bank earnings, which he said was one factor holding back the recovery of the world economy........................

"If you go back to 1980, the earnings of the financial sector of the S&P 500 companies was less than 10 per cent." Fast forward to the time just prior to the financial crisis, and the financial sector accounted for fully one third of earnings among the world's largest companies. Blundell-Wignall then went through as series of graphs, showing that the US financial sector is now back to a better position now than it was before the crisis. He also suggested that while the European financial sector is still in the doldrums, in time it will also be in a similar position to its pre-financial crisis health.

That is not a good news story for him, though. "Let's be realistic here," he said. "The financial sector is supposed to be the sector that intermediates between the real economy and the investors. That's what greases the wheels of capitalism. Where did we get off thinking that the financial sector can just rip out one third of all earnings for themselves?"...............




OECD Journal: Financial Market Trends 2014
Volume 2013/2
© OECD 2014


Bank business models and the separation issue
by Adrian Blundell-Wignall, Paul Atkinson and Caroline Roulet*


The main hallmarks of the global financial crisis were too-big-to-fail institutions taking on too much risk with other people’s money while gains were privatised and losses socialised. It is shown that banks need little capital in calm periods, but in a crisis they need too much – there is no reasonable ex-ante capital rule for large systemically important financial institutions that will make them safe. The bank regulators paradox is that large complex and interconnected banks need very little capital in the good times, but they can never have enough in an extreme crisis. Separation is required to deal with this problem, which derives mainly from counterparty risk. The study suggests banks should be considered for separation into a ring-fenced non-operating holding company (NOHC) structure with ring-fencing when they pass a key allowable threshold for the gross market value (GMV) of derivatives, a case which is reinforced if the bank has high wholesale funding and low levels of liquid trading assets.............


In 1998 the GMV of derivatives was around 8% of world GDP and, in 2007 just prior to the crisis, it reached 21% of GDP before sky-rocketing to 58% of world GDP as a consequence of the sharp rise in volatility to unprecedented levels (which directly affects the value of derivatives). This period led to massive changes in counterparty obligations (including those for AIG noted earlier). This made central bank lending the key to avoiding a collapse in the global financial system.  Non-financial corporate debt has been relatively stable at around 15% of world GDP.3  General government debt was also relatively stable in the global economy at around 45% of world GDP prior to the crisis, but it has since risen sharply to just under 60% of world GDP – underlining the notion that the financial sector crisis was the cause of the more recent deterioration in the indebtedness of the public sector, not the other way around.  It would be very surprising, given the above developments, if derivatives and the extent of wholesale funding (counterparty risk) were not to figure strongly in any explanation of bank default risk.


V. The OECD structural separation proposal

Following the 2008 crisis, the OECD Secretariat was amongst the first to propose separation as necessary for the future stability of the financial system.15 It proposes a nonoperating holding company (NOHC) structure for banks that require separation. In this article, a separation threshold for banks based on the research about the determinants of the DTD is proposed, and once a bank moves beyond that threshold the offending securities businesses will be separated from the core bank and both would be ring-fenced from each other. The aim of separation is to ensure that deposit banking is very safe, so that the central bank and/or the taxpayer do not need to support the bank each time derivatives and repo margin calls cannot be met in a liquidity crisis. ...............


Criticisms of the OECD separation proposal

Since the OECD first made its NOHC proposal in 2009, it has received five broad sets of comments or criticisms (other than banks’ resistance based on a desire to return to rentseeking returns so prevalent in the first half of the 2000s). These are:
1. That Lehman Brothers and AIG were not universal banks that could be considered for separation, and yet they caused systemic concerns.
2. That it was not the GSIFI banks that failed during the crisis; it was the specialised mortgage banks involved in the real estate boom busts in the USA, the UK, Ireland and Spain that mainly failed.
3. That separating core deposit banking will force investment banks into more wholesale funding, which the DTD model results suggest is a riskier business model feature.
4. That it is legally too complex to separate assets and liabilities while meeting all of the tax and corporate laws of the country concerned.
5. That separation with full ring fencing of all subsidiaries is essentially Glass-Steagall, so why bother with NOHC?


Ad 1: Investment banks failed........


Ad 2: Mortgage banks failed..............


Ad 3: Separated investment banks would become riskier..............


page  14

Ad 4: Legal complexity

The fourth criticism does not square with the facts. In March 1997 Australia’s Wallis (1997) Review recommended the NOHC as a safe business model, without trying to suggest it as a structural regulation. It was seen as the best method to quarantine entities in a group containing a depository institution (to protect against creditors of one entity seeking to pursue the other entities of a group). The 1998 Financial Sector (Shareholdings) Act amended the 1959 Banking Act to permit NOHCs as a legal corporate structure. However, there was no actual adoption of NOHCs due to corporate and tax law complications (impediments under the Corporations Act, 2001, and the taxation laws). In 2007, Macquarie Bank was the only Australian bank that had highly-levered securities businesses mixed into a common structure, and the bank could see that it was very much in its interest to adopt the NOHC structure. Importantly, it was also encouraged strongly to do so by the Australian Prudential Regulatory Authority (APRA). To deal with the complexity issue, the Financial Sector Legislation Amendment (Restructures) Bill (2007) was passed. This created two simplifying instruments:
Restructure instruments: to grant relief to the specific statutory impediments to NOHC affiliates complying with the requirements of corporate law.

Internal Transfer Certificates: issued by APRA, to facilitate the rearrangement of assets and liabilities of the different activities into their separate business lines.
To complete the process, a number of amendments to the Income Tax Assessment Act 1997 were passed, i.e. amendments to the consolidation rules and capital gains tax aspects that were impediments to restructuring. Macquarie Bank adopted the NOHC structure in 2007, the very same year as the legislation was passed, and this structure served it very well as the global crisis unfolded.


Ad 5: Full (Glass-Steagall-type) separation may be better
Finally, the fifth comment may be right – that full separation is a superior business model. The current authors do not believe so because belonging to a ring-fenced group still carries many advantages. These include synergies in the technology platform, and back office and human resources sharing. Cross-selling would be permitted, though with armslength pricing. The business model has great advantages for the equity investor, who will receive dividends from diversified sources. If traditional banking falls on hard times, dividends may still be paid from the investment bank, and other business lines. This will make the group desirable from an equity raising perspective. Finally, the NOHC model has advantages politically, in allowing large national champion banks to stay as conglomerate entities, but in a form that is much safer for the taxpayer.



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