Guest post. Translated from the French by Tim Gupwell.
The debate on growth which is starting to take shape has overshadowed an event which is less spectacular but just as decisive. It concerns the deleveraging of banks, which will have an influence on growth as it is accompanied by a reduction in credit for the economy. The higher the ratio, the less abundant will be the credit. Indeed, the finance ministers adopted last Wednesday a compromise with regard to the adaptation of the prudential regulations of Basel 3 into European law; a basis for the drafting up of a future directive entitled CRD4…..
The battle was fierce between the British and their allies on one side, and the French and Germans on the other. It was a matter of determining under what conditions the regulatory authorities of a country would be able to increase, for the benefit of the banks under their jurisdiction, the core ratio (which expresses the relationship between banks’ capital reserves and liabilities.) The former wanted to be free to do as they wished and to be able to increase it whenever they wanted, intending thereby to gain a competitive advantage, for such a type of supplementary constraint would also have to be respected by all the foreign subsidiaries of the banks present on their territory; in the European case less well placed to increase their capital, leading them inevitably to a reduction of their activities.
Michel Barnier, the European Commissioner, battled hard against a project threatening the single market in his opinion – if each country could independently decide their capital norms – whilst at the same time having to push for the compromise which it was vital to find in the current context. The French and German representatives for their part, by going head to head with the British, highlighted the weak position in which their banks find themselves, and which they still attempt to deny.
The agreement reached is expected to be finalized by the ministers of the 27 member states on the 15th May, but an even bigger mouthful to swallow is that of the norms for liquidities which measure the banks’ capacity to mobilize resources on a short-term basis in order to meet their obligations. A subject about which they are particularly sensitive in these times of the dysfunctional interbank market and tensions in the repo markets (the enormous market in which they borrow short term liquidities in return for the temporary assignment of their assets as collateral.)
Frantically offloading their assets in order to reinforce their core capital ratios, they are not only providing the opportunity for their buyers (non-European banks, hedge funds and investment funds) to snap up some bargains, but are also contributing to a fall in prices of these very assets (since the supply is truly abundant), and consequently to lower levels of liquidity in the market (since buyers demand more). This increases in turn the need to sell yet more new assets, and so on and so forth.
Analysts from the Bank of England have just calculated that the massive injections from the Central European bank will not compensate for the shrinkage of the market occasioned by this fall in prices and that the banks will not be able to refinance themselves. The only remaining solution is to renew the operation or to take action with respect to the falling prices of the collateral on which the Repo market depends, by regulating in order to limit it. Since this market, the meeting place of both the regulated banking sector and the shadow-banking system, has become one of the greatest worries of the regulator.
It is for this reason that the Financial Stability Board (FSB) has been tasked with drawing up before the end of the year some recommendations to the governments of the G20, with a view to establishing some new operating rules for shadow banking. To begin with, an attempt to describe the enormous heterogeneous sector of activity has been realized, which, according to Michel Barnier is worth half of the total global value of the financial sector. In the United States alone, it is said to represent 2 700 billion dollars, which is half its highest level of 2007.
The regulators have also identified the different mechanisms through which the repo markets could destabilize the financial system as a whole. Something which ultimately amounts to an all-embracing problem: that of an actual increase in value of the assets… which reveals the necessity of regulating the repo markets, and therefore the shadow banking system which plays a part in it.
The mega-banks would not be totally opposed, taking into account (to make up for it) the relaxation of the Dodd-Frank Wall street reform act, whose implementation decrees are delayed due to it being still under consideration. A delegation of Managing Directors from these mammoth companies has just brought before the Fed their register of grievances to this end. But meanwhile, after having undergone a significant downsize, the shadow banking system has gradually started to prosper again as the threat of tentative regulatory measures takes shape. The Mega-banks had set this date a long time ago and explained that a choice would have to be made! Obviously, the moment has come!
The regulators are caught up in other contradictory imperatives, prompted on one side to acknowledge the increase in the volume of the security deposits in the clearing houses which they created and which are used at their request for an increasing number of transactions but which possess the flaw of concentrating in their heart all the risks – and on the other to combat the pro-cyclical margin calls which contribute to a devaluation of assets, thus undermining the pillars on which the repo markets repose. Lord Turner, a member of the FSB and president of the Financial Services Authority (FSA), the British regulatory authority, is in charge of the dossier and seeks to impose limits to margin calls, this order to a market participant to provide supplementary funds as a guarantee. In the end, that would amount to an about turn by undertaking in a regulation of the products after having gambled everything on a regulation of the structures.
None of this will change the fact that this regulation as it is conceived will not provide the solutions. The latest episode to prove this is that the operators of HFT (High frequency trading) are in the process of abandoning the world’s major stock markets in order to join exchange platforms that are less heavily regulated, worried by the threat of tentative, legally binding regulations currently under discussion. Such is the observation made by Duncan Niederaurer, the Managing Director of NYSE Euronext, the operator of the stock exchanges in New York, Paris, Amsterdam, Brussels and Lisbon. The tendency is in fact towards a very heavy drop in the volume of transactions, as well as the resulting reduction in profits.
You think you are mastering a situation by grabbing one end, and it escapes by the other.