Tag Archives: Financial Stability Board

10 x Hopelessly Lax = ?

The economist Sir John Vickers, himself an ex Bank of England Chief Economist, recently had a pop at the current Bank of England’s governor and chair of the Financial Stability Board, Mark Carney.  He countered Carney’s assertion that “the largest banks are required to have as much as ten times more of the highest quality capital than before the crisis” with the quip that “ten times better than hopelessly lax is not a useful measure”. I particularly liked Vickers observation that equity capital is “a residual, the difference between two typically big numbers, of which the asset side is hard to measure given the nature of banking, and dependent on accounting rules”.

In a recent article in the FT, Martin Wolf joined in the Carney bashing by saying the ten times metric “is true only if one relies on the alchemy of risk-weighting” and that banking regulatory requirements have merely “gone from the insane to the merely ridiculous” since the crisis. Wolf acknowledges that “banks are in better shape, on many fronts, than they were a decade ago” but concludes that “their balance sheets are still not built to survive a big storm”.

I looked through a few of the bigger banks’ reports (randomly selected) across Europe and the US to see what their current risk weighted assets (RWA) as a percentage of total assets and their tier 1 common equity (CET1) ratios looked like, as below. The wide range of RWAs to total assets, indicative of the differing business focus for each bank, contrasts against the relatively similar level of core “equity” buffers.

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Wolf and Vickers both argue that higher capital levels, such as those cited by Anat Admati and Martin Hellwig in The Bankers’ New Clothes, or more radical structural reform, such as that proposed by Mervyn King (see this post), should remain a goal for current policymakers like Carney.

The latest IMF Stability Report, published yesterday, has an interesting exhibit showing an adjusted capital ratio (which includes reserves against expected losses) for the global systemically important banks (GSIBs), as below.

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This exhibit confirms an increased capital resilience for the big banks. Hardly the multiple increases in safety that Mr Carney’s statements imply however.

What now for “too big to fail” insurers on G-SII list?

Insurers and industry participants have reacted with the expected bemusement to the announcement on the 18th of July from the Financial Stability Board (FSB) on the list of “too big to fail” insurers, aka G-SIIs or Global Systemically Important Insurers. To be fair, the list of nine – three US, five European and one Chinese – does look inconsistent. No Japanese for example or the inclusion of Aviva but the exclusion of Zurich.

Industry groups such as the Geneva Association and Insurance Europe have asked for clarity on the criteria and more disclosure on the impact. The timetable released by the FSB includes announcing the reinsurers to be designated as G-SIIs by mid 2014 (now that will be interesting given the global focus of a reinsurer’s business model) and the finalization of the additional loss absorption measures for G-SIIs by the end of 2015 with an implementation date of the start of 2019.

The generous diversification credits that large insurers have calculated using economic capital models (likely to be used under Solvency II) can be seen in the graph below based upon data from a sample of published results from 2012 annual reports of a number of European insurance groups.

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Capital Model Breakdown European Insurers YE2012

The graph shows assumed diversification across risk modules of 30% to 40% but does not show the significant diversification assumed by insurers within risk modules, particularly for the larger firms with a wide spread of business classes. Munich Re, for example, highlights a further 30% and 50% discount in their non-life underwriting risk and market risk modules respectively. Aviva is perhaps startlingly open when it revealed, in its year end results presentation, a diversification discount within its business unit of 45% and a further diversification discount across business units and jurisdictions of 40%. Their gross undiversified capital of £31 billion reduced by 68% to £10 billion after been sprinkled with the diversification magic dust.

Given the competitive advantage that size and diversity brings under the risk based regulatory capital systems being introduced or planned for introduction across the globe, the large insurance groups just named as G-SIIs will likely step up their lobbying efforts to a new level in the next few years against any costly or detrimental measures by the FSB that could impact their hard won competitive advantage. Another avenue for the G-SII to negate any capital impact is to sharper their pencils further on the diversification effects calculated in their economic capital models!