FTSE 100
Dow Jones

Wednesday, 18 March 2009

The Annotated Turner Report

Capital adequacy, accounting and liquidity

1. The quality and quantity of overall capital in the global banking system should be increased, resulting in minimum regulatory requirements significantly above existing Basel rules. The transition to future rules should be carefully phased given the importance of maintaining bank lending in the current macroeconomic climate.

2. Capital required against trading book activities should be increased significantly (e.g. several times) and a fundamental review of the market risk capital regime (e.g. reliance on VAR measures for regulatory purposes) should be launched.

3. Regulators should take immediate action to ensure that the implementation of the current Basel II capital regime does not create unnecessary procyclicality; this can be achieved by using ‘through the cycle’ rather than ‘point in time’ measures of probabilities of default.

4. A counter-cyclical capital adequacy regime should be introduced, with capital buffers which increase in economic upswings and decrease in recessions.
Conclusion from all of the above: Basel II doesn’t work

5. Published accounts should also include buffers which anticipate potential future losses, through, for instance, the creation of an ‘Economic Cycle Reserve’.

Published accounts? Any accounts should show the financial state of the company. I think he means banks should hold extra reserves (make general provisions) against potential future losses.

6. A maximum gross leverage ratio should be introduced as a backstop discipline against excessive growth in absolute balance sheet size.

Which is fine until banks start trying to get assets off their balance sheets

7. Liquidity regulation and supervision should be recognised as of equal importance to capital regulation.

More intense and dedicated supervision of individual banks’ liquidity positions should be introduced, including the use of stress tests defined by regulators and covering system-wide risks.

Introduction of a ‘core funding ratio’ to ensure sustainable funding of balance sheet growth should be considered.

Liquidity regulation would be a big change for the FSA, but it is nothing new. It was part of the Bank of England’s supervision of banks.

Institutional and geographic coverage of regulation

8. Regulatory and supervisory coverage should follow the principle of economic substance not legal form.

This is not new.

9. Authorities should have the power to gather information on all significant unregulated financial institutions (e.g. hedge funds) to allow assessment of overall system-wide risks. Regulators should have the power to extend prudential regulation of capital and liquidity or impose other restrictions if any institution or group of institutions develops bank-like features that threaten financial stability and/or otherwise become systemically significant.

Regulators should have the power to regulate those whom they are required to regulate. The rest of the world is not their business.

10. Offshore financial centres should be covered by global agreements on regulatory standards.

And how do you expect to get the offshore financial centres to agree to that?

Deposit insurance

11. Retail deposit insurance should be sufficiently generous to ensure that the vast majority of retail depositors are protected against the impact of bank failure (note: already implemented in the UK).

12. Clear communication should be put in place to ensure that retail depositors understand the extent of deposit insurance cover.

Read that as: pull the wool over the eyes of the sheep.

UK Bank Resolution

13. A resolution regime which facilitates the orderly wind down of failed banks should be in place (already done via Banking Act 2009).

How about a regime that strips out the good parts of failed banks to give us at least some sort of residual banking system.

Credit rating agencies

14. Credit rating agencies should be subject to registration and supervision to ensure good governance and management of conflicts of interest and to ensure that credit ratings are only applied to securities for which a consistent rating is possible.

There is always a conflict of interest unless they do it for free. Credit ratings can never be consistent.

15. Rating agencies and regulators should ensure that communication to investors about the appropriate use of ratings makes clear that they are designed to carry inference for credit risk, not liquidity or market price.

Pull the other one. The market publishes data for spreads for given ratings.

16. There should be a fundamental review of the use of structured finance ratings in the Basel II framework.

Basel II took a decade to negotiate and implement. Did you have any particular end date in mind for this review?


17. Remuneration policies should be designed to avoid incentives for undue risk taking; risk management considerations should be closely integrated into remuneration decisions. This should be achieved through the development and enforcement of UK and global codes.

Try that on all the banks in London and every Alphonse, Gustav, Marvin and Klaus in the City will be on the first plane to Switzerland. Limit it to UK incorporated banks and nobody will care.

Credit Default Swap (CDS) market infrastructure

18. Clearing and central counterparty systems should be developed to cover the standardised contracts which account for the majority of CDS trading.

This was not the problem. They all cleared correctly. The problem was the big unreported exposures and at least one unregulated entity in the UK market with a $500 billion book.

Macro-prudential analysis

19. Both the Bank of England and the FSA should be extensively and collaboratively involved in macro-prudential analysis and the identification of policy measures. Measures such as countercyclical capital and liquidity requirements should be used to offset these risks.

Are you saying Gordon Brown doesn’t listen?

20. Institutions such as the IMF must have the resources and robust independence to do high quality macro-prudential analysis and if necessary to challenge conventional intellectual wisdoms and national policies.

Correct. They have been doing so for years. Sadly, Gordon Brown didn’t listen to them.

FSA supervisory approach

21. The FSA should complete the implementation of its Supervisory Enhancement Program (SEP) which entails a major shift in its supervisory approach with:

Increase in resources devoted to high impact firms and in particular to large complex banks.

Focus on business models, strategies, risks and outcomes, rather than primarily on systems and processes.

Focus on technical skills as well as probity of approved persons.

Increased analysis of sectors and comparative analysis of firm performance.

Investment in specialist prudential skills.

More intensive information requirements on key risks (e.g. liquidity)

A focus on remuneration policies

Blimey, now they admit all the things they haven’t been doing properly

22. The SEP changes should be further reinforced by

Development of capabilities in macro-prudential analysis

A major intensification of the role the FSA plays in bank balance sheet analysis and in the oversight of accounting judgements.

No the FSA is going to be full of accounting experts. I think such matters should be left to the true experts and independent adjudicators.

Firm risk management and governance

23. The Walker Review should consider in particular:

Whether changes in governance structure are required to increase the independence of risk management functions.

The skill level and time commitment required for non-executive directors of large complex banks to perform effective oversight of risks and provide challenge to executive strategies.

Nothing to do with the FSA. This is about corporate governance and a matter for the DTI. Oh, that’s gone.

Utility banking versus investment banking

24. New capital and liquidity requirements should be designed to constrain commercial banks’ role in risky proprietary trading activities. A more formal and complete legal distinction of ‘narrow banking’ from market making activities is not feasible.

We used to call it Glass-Steagall. Shame it never happened here.

Global cross-border banks

25. International coordination of bank supervision should be enhanced by

The establishment and effective operation of colleges of supervisors for the largest complex and cross-border financial institutions.

The pre-emptive development of crisis coordination mechanisms and contingency plans between supervisors, central banks and finance ministries.

Then you can play at simulated crises on Saturday afternoons for double overtime

26. The FSA should be prepared more actively to use its powers to require strongly capitalised local subsidiaries, local liquidity and limits to firm activity, if needed to complement improved international coordination.

There’s a nice little office building I know in Zug. Fully wired, great views of the lake.

European cross-border banks

27. A new European institution should be created which will be an independent authority with regulatory powers, a standard setter and overseer in the area of supervision, and will be significantly involved in macro-prudential analysis. This body should replace the Lamfalussy Committees. Supervision of individual firms should continue to be performed at national level.

A regulator for regulators? To whom is it accountable? The European Commission? ‘Nuff said.

28. The untenable present arrangements in relation to cross-border branch pass-porting rights should be changed through some combination of:

Increased national powers to require subsidiarisation or to limit retail deposit taking

Reforms to European deposit insurance rules which ensure the existence of pre-funded

resources to support deposits in the event of a bank failure.

That building in Zug. I think we can get it for about 70 SFr per square metre, but we will have to move fast to beat the rush.

Open questions for further debate

29. Should the UK introduce product regulation of mortgage market Loan-to-Value (LTV) or Loan-to-Income (LTI)?

If you put up a limit then banks stupid banks will find other ways to lose money.

30. Should financial regulators be willing to impose restrictions on the design or use of wholesale market products (e.g. CDS)?

Financial regulators would never be able to keep up with the wholesale market. One of the factors in competitive advantage in investment banking is the speed to market with new products. Those who go to market with bad products, and those who buy them, deserve to go to the wall.

31. Does effective macro-prudential policy require the use of tools other than the variation of countercyclical capital and liquidity requirements e.g.

Through the cycle variation of LTV or LTI ratios.

Regulation of collateral margins (‘haircuts’) in derivatives contracts and secured financing transactions?

No. Next question.

32. Should decisions on for instance short selling recognise the dangers of market irrationality as well as market abuse?

Now you want to regulate for stupidity? “You can’t do that just in case somebody soes something really stupid”. Now that is stupid. The regulator has to be aware that these things mught happen. He doesn’t have to use that as an excuse to stop people doing something.

No comments: