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Tuesday, 24 October 2017

Regulators, with capital rules in mind, open can of worms

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Anthony Peters, SwissInvest Strategist

Jose Manuel Barroso, President of the European Commission, is no doubt a man of many talents but he apparently understands as much about banking as I do about breeding llamas. His CV reads just like that of any typical 21st century political hack and includes such gems as “…He was also Secretary of State of Foreign Business and Secretary of State of Cooperation in the Eleventh and Twelfth Constitutional Governments…”, whatever that might mean. What it is that might qualify him to opine on bank capital issues escapes me, but opine he did and what a load of poppycock he is spouting.

By coincidence, I met up last night with my tame central banker who decided to pull my leg about the apparently uncritical support which I dole out in favour of bankers in this, the ongoing credit and finance crisis which is largely of our making. It all came about as I was being critical of the effect which more stringent capital rules are having on the basic process of making markets. How, I was wondering, can the authorities expect banks to be more strict and verifiable in their marking to market if they remove the most basic tool of functioning markets, namely risk capital?

You can’t mark-to-market when there’s no market to mark to and we all know the mess that was caused during the first leg of the current banking crisis when it was found that some hedge funds had apparently intentionally booked assets for which there was no discernible market and that they therefore didn’t need to mark. Banks might only be one component of the economy, but what they are trying to do – probably more due to ignorance than malevolence – is equivalent to taking the hub out of a wheel – all the spokes and rims and tyres are just bits if the hub is removed.

Banks require capital – and if Barroso has anything to do with it, a lot more of it too. They also need to pay those who provide capital – why should anyone care to provide capital for free? In various extensions to European Directive CRD IV, banks can be obliged to withhold both dividends to shareholders and bonuses to staff, if the bank doesn’t make sufficient profit. Of course I understand the political and idealistic (if not ideological) sentiment but then how does Sr Barroso expect capital to be raised? “Give us yer money and we’ll legislate to give yer nothing in return?” A likely world largely inhabited by centre-left politicians and academics… and Presidents of Commissions.

Banks might only be one component of the economy, but what they are trying to do is equivalent to taking the hub out of a wheel – all the spokes and rims and tyres are just bits if the hub is removed

We in the capital markets were dancing in the aisles last week because the mighty Deutsche Bank had just succeeded in crossing the Rubicon in raising €1.5bn of highly risky two-year senior unsecured debt – that’s pretty much where risk appetite ended – and the authorities are still banging on about more and more capital. I have spent several years reminding people that raising the regulatory capital bar too far will kill the economics of banking and there are already rumblings that instead of raising further capital, the banks will look to simply shrink their balance sheets. That is not what the authorities had in mind.

And now for the conundrum of the day – if banks won’t and, given the capital constraints, can’t lend, does that mean that corporations will have to more readily turn to the public markets? If so, how do we handle that if the process of market-making is broken – due to capital constraints? If insurers and other institutional investors have to stand up and do the lending which the banks no longer can and will, do they become shadow banks, the likes of which the regulator hates because they’re not regulated? The potential can of worms is nearly as large as the banking crisis itself. I have been arguing since the beginning of the so-called “credit crunch” that the free flow of credit and the tightening of capital rules are more or less mutually exclusive. Four years in and Jose Manuel Barroso hasn’t got that yet but I guess, given his CV, that is no great surprise.

Fear and greed

Meanwhile, I note that the DAX closed last night at 5,994.47 points which is just over 1,000 points above its September 23 intraday trading low. In terms of fear and greed, that takes some beating. Into this, HSBC’s equity strategy group point out that yield sectors are at a their cheapest P/E multiples in 40 years. I would simply like to humbly add that long bond yields are at their lowest in a lot more than 40 years but that I don’t believe constitutes a compelling reason to sell.

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