What is capital?

[jpatter666]

I thought this was a very clear article (for a novice -- me) about what bank capital is. Thought others might find useful and I'd be curious to hear our expert opinions.

http://www.npr.org/blogs/money/2013/05/20/185511800/ask-a-banker-capital-capital

[astonas]

Re: What is capital?

I thought this was a very clear article (for a novice -- me) about what bank capital is. Thought others might find useful and I'd be curious to hear our expert opinions.

http://www.npr.org/blogs/money/2013/05/20/185511800/ask-a-banker-capital-capital

The "ask a banker" segment is one of the more uneven ones Planet Money does. (Often very well-supported, but also with some pretty serious anglo-Saxon and TBTF bias, which sometimes takes over.) You really have to follow the links to see if Levine is blindly echoing a TBTF orthodoxy, or saying something well-worth listening to. In this case, he did a pretty good job, but some things he's written are pretty transparently defenses of the indefensible.

There's at least one reference linked in this piece that is well worth following (highly informed writing, with good supporting evidence):

May 16, 2013, 12:01 am The Myth of a Perfect Orderly Liquidation Authority for Big Banks
By SIMON JOHNSON



There's also one piece that Johnson himself links to, but is behind a paywall. I suspect there's pretty important information behind this link:

Writing in The Financial Times on Monday, Wolfgang Schäuble, Germany’s finance minister, made it clear that we are a long way from having an integrated bank resolution regime in Europe. In a crisis, it’s every finance minister and central banker for himself.

Anyone subscribe to the FT? Is there anything new behind that link, or is it all stuff we've covered here before?

Another link from the "Ask a Banker" piece that may be interesting is this one:

Why is finance so complex?

Again, it too has a pretty strong pro-bank bias, but the logic is worth being familiar with. It is easy to see both how it could be logically correct to an extent, and also how the effect could be exaggerated in the minds of bankers to arrive at completely silly conclusions.

When they argue that people who criticize TBTF banks "don't understand the way banks help the economy," I suspect it is these sorts of game-theory arguments they are referring to. But the reductio ad absurdum is both easy to understand, and obvious to spot. By the end of the piece, the author has credited banking with the very existence of civilization itself!

[jiimbergin]

Re: What is capital?

Astonas, you do not have to pay to see the Financial Times article. Simply register and sign in. I believe there are limits as to how many articles you can see in a month. The summary sentence you posted basically sums up the whole article.

[jpatter666]

Re: What is capital?

If you register with the FT you get a certain number of free articles/month.

[Raz]

Re: What is capital?

May 12, 2013 6:49 pm

Banking union must be built on firm foundations

By Wolfgang Schäuble


Task needs more than cross-border supervision, writes Wolfgang Schäuble

©Getty


A year ago, European leaders gathered in Brussels to create a single supervisor to oversee the region’s systemically important banks. This momentous step is nearing completion. But it is only one stage in an even more ambitious undertaking: the building of a banking union for Europe.
The German government was among the first to float the notion of a European supervisor as a way to combat the destructive synergies between strained banks and indebted states in the eurozone. Today, more than ever, I see a banking union covering supervision, resolution, fiscal backstops and rules for deposit insurance as an urgent necessity.

The merits of a banking union are rarely disputed. But there is a debate about how to shape its governance and accountability; and about what we can deliver in the short term and what our ultimate goals should be.

In the past decade, public and private debt levels have rocketed. This debt will have to come down. And for our banks to fulfil their role as financiers of the economy, they will have to deleverage. Yet states can only do so much to help them.

The single supervisor, scheduled to start operating under the European Central Bank in the summer of 2014, will not only help prevent banks from accumulating excessive risk. Standing above national authorities, it will increase the pressure on banks to repair their balance sheets.
Yet pursuing this clean-up exercise swiftly and without burdening taxpayers will require more than cross-border supervision. It will need a mechanism to restructure or wind up the weakest banks in an orderly, predictable and uniform fashion throughout Europe. The best way to break the link between banks and states is to ensure that enrolling taxpayers to rescue banks becomes the exception rather than the rule.

As the rescue of Cyprus has shown, we need predictability about when shareholders and creditors – and in what order – would be called upon to bail in or wind up a bank. To rely on ad hoc approaches until 2018, as foreseen by the draft European bank recovery and resolution directive, would be misguided. We need credible EU bail-in rules as soon as possible.

The European Commission will soon put forward a proposal for a resolution mechanism. We will assess it with an open mind. Yet while today’s EU treaties provide adequate foundation for the new supervisor and for a single resolution mechanism, they do not suffice to anchor beyond doubt a new and strong central resolution authority. We should not make promises we cannot keep. The overly optimistic predictions about a single supervisor starting work as early as January 2013 cost the EU credibility.

While supervision keeps risk-taking in check, resolution is more intrusive. It is about apportioning the costs of risks, if they materialise, among stakeholders. When a bank is wound up, money and jobs are usually lost. Those affected will seek redress. If there is an activity that needs a solid legal base, it is resolution. This is particularly true in a European context. The EU does not have coercive means to enforce decisions. Its historical roots are young. Its democratic legitimacy could be improved upon. What it has are responsibilities and powers defined by its treaties. To take them lightly, as is sometimes suggested, is to tamper with the rule of law.

Limited treaty changes would not just provide a safe legal base for a European resolution authority; they could create a better separation between supervision and monetary functions in the ECB, allowing non-eurozone EU members to join the supervisory regime on an equal footing; finally, they would underline the irreversibility of integration. Amending the treaties takes time. Luckily, the alternative is not between a legally shaky resolution authority now and the postponement of repair work on the banks.

A two-step approach could start with a resolution mechanism based on a network of national authorities as soon as the new supervisor is operational, the resolution directive has been adopted and the Basel III capital requirements are in place.
Instead of a single European resolution fund – which the industry would take many years to fill – such a model would lean on national funds, which already exist in several member states.
A resolution mechanism focused on effective European co-ordination and cross-border issues would have other advantages. Unlike supervisory law, by now largely harmonised, the laws governing bank resolution and restructuring vary widely. A decentralised approach may prove better at safely applying these laws. Likewise, significant cross-border resolutions, if any, are likely to involve operations in and outside the eurozone, strengthening the case for a co-ordinated approach.

A banking union of sorts can thus be had without revising the treaties, including a single supervisor; harmonised rules on capital requirements, resolution and deposit guarantees; a resolution mechanism based on effective co-ordination between national authorities; and effective fiscal backstops, also including the European Stability Mechanism as last resort.

This would be a timber-framed, not a steel-framed, banking union. But it would serve its purpose and buy time for the creation of a legal base for our long-term goal: a truly European and supranational banking union, with strong, central authorities, and potentially covering the entire single market.

The writer is German finance minister

http://www.ft.com/intl/cms/s/0/8bdaf...#axzz2VLzW6W7R

[astonas]

Re: What is capital?

Thanks for posting this, Raz!

May 12, 2013 6:49 pm

Banking union must be built on firm foundations

By Wolfgang Schäuble


Task needs more than cross-border supervision, writes Wolfgang Schäuble

©Getty


A year ago, European leaders gathered in Brussels to create a single supervisor to oversee the region’s systemically important banks. This momentous step is nearing completion. But it is only one stage in an even more ambitious undertaking: the building of a banking union for Europe.

The German government was among the first to float the notion of a European supervisor as a way to combat the destructive synergies between strained banks and indebted states in the eurozone. Today, more than ever, I see a banking union covering supervision, resolution, fiscal backstops and rules for deposit insurance as an urgent necessity.

The merits of a banking union are rarely disputed. But there is a debate about how to shape its governance and accountability; and about what we can deliver in the short term and what our ultimate goals should be.

In the past decade, public and private debt levels have rocketed. This debt will have to come down. And for our banks to fulfil their role as financiers of the economy, they will have to deleverage. Yet states can only do so much to help them.

The single supervisor, scheduled to start operating under the European Central Bank in the summer of 2014, will not only help prevent banks from accumulating excessive risk. Standing above national authorities, it will increase the pressure on banks to repair their balance sheets.

Yet pursuing this clean-up exercise swiftly and without burdening taxpayers will require more than cross-border supervision. It will need a mechanism to restructure or wind up the weakest banks in an orderly, predictable and uniform fashion throughout Europe. The best way to break the link between banks and states is to ensure that enrolling taxpayers to rescue banks becomes the exception rather than the rule.

As the rescue of Cyprus has shown, we need predictability about when shareholders and creditors – and in what order – would be called upon to bail in or wind up a bank. To rely on ad hoc approaches until 2018, as foreseen by the draft European bank recovery and resolution directive, would be misguided. We need credible EU bail-in rules as soon as possible.

The European Commission will soon put forward a proposal for a resolution mechanism. We will assess it with an open mind. Yet while today’s EU treaties provide adequate foundation for the new supervisor and for a single resolution mechanism, they do not suffice to anchor beyond doubt a new and strong central resolution authority. We should not make promises we cannot keep. The overly optimistic predictions about a single supervisor starting work as early as January 2013 cost the EU credibility.

While supervision keeps risk-taking in check, resolution is more intrusive. It is about apportioning the costs of risks, if they materialise, among stakeholders. When a bank is wound up, money and jobs are usually lost. Those affected will seek redress. If there is an activity that needs a solid legal base, it is resolution. This is particularly true in a European context. The EU does not have coercive means to enforce decisions. Its historical roots are young. Its democratic legitimacy could be improved upon. What it has are responsibilities and powers defined by its treaties. To take them lightly, as is sometimes suggested, is to tamper with the rule of law.

Limited treaty changes would not just provide a safe legal base for a European resolution authority; they could create a better separation between supervision and monetary functions in the ECB, allowing non-eurozone EU members to join the supervisory regime on an equal footing; finally, they would underline the irreversibility of integration. Amending the treaties takes time. Luckily, the alternative is not between a legally shaky resolution authority now and the postponement of repair work on the banks.

A two-step approach could start with a resolution mechanism based on a network of national authorities as soon as the new supervisor is operational, the resolution directive has been adopted and the Basel III capital requirements are in place.

Instead of a single European resolution fund – which the industry would take many years to fill – such a model would lean on national funds, which already exist in several member states.

A resolution mechanism focused on effective European co-ordination and cross-border issues would have other advantages. Unlike supervisory law, by now largely harmonised, the laws governing bank resolution and restructuring vary widely. A decentralised approach may prove better at safely applying these laws. Likewise, significant cross-border resolutions, if any, are likely to involve operations in and outside the eurozone, strengthening the case for a co-ordinated approach.

A banking union of sorts can thus be had without revising the treaties, including a single supervisor; harmonised rules on capital requirements, resolution and deposit guarantees; a resolution mechanism based on effective co-ordination between national authorities; and effective fiscal backstops, also including the European Stability Mechanism as last resort.

This would be a timber-framed, not a steel-framed, banking union. But it would serve its purpose and buy time for the creation of a legal base for our long-term goal: a truly European and supranational banking union, with strong, central authorities, and potentially covering the entire single market.

The writer is German finance minister

http://www.ft.com/intl/cms/s/0/8bdaf...#axzz2VLzW6W7R

It looks like the carrots and the stick are both still very much in play, with no sudden turnaround in overall germanic goals. A little money for weak states now, in exchange for signing up for a "timber-framed" banking union. But not enough relief to actually let anyone breath more easily, until the steel frame goes up, as states modify constitutions to permit ceding sovereignty via EU treaty.

The word "potentially" in the last line is what I find most interesting. I wonder if he is cracking open a door for Britain, (English-language, financial-industry publication) to ask to be an exception. That's pretty dramatic, given that Merkozy pounded on Cameron pretty hard based on "one set of rules for all" logic. Until now, I wasn't even sure if the real intent was to actually force Britain to leave the EU entirely.

But Hollande and the mediterraneans are not the eager partners that Sarkozy and company were, so it could very well make sense for the germanics to lighten up on the anglo-saxons to get support for forcing the south, either momentarily until the banking union is in place (should Hollande be ousted) or longer-term (if he survives).

Here too, is both carrot and stick. Britain can join the germanics to influence resolution mechanisms to favor the City (perhaps even gain some exemptions) but only if it signs on to getting France and co. to swallow them. Or maybe the City will be in a position to profit when some of the weaker European banks get broken up and sold for parts?

It's kind of amazing how open Schäuble is being about all this. He's either worried about spooking the markets with Germany's response to the final resolution directive, or he's bluffing to influence specific changes before the final draft. Either way, he clearly hasn't been sufficiently trained to be a central banker. ;-)





... so ... after I wrote the above commentary, I went digging around to see what changes were made between one draft version and the next. Remember that Schäuble's editorial was published on May 12 in response to the draft it linked, which was written in March. Here's what happened since:

Bail-In by 2016?
Posted on May 22, 2013

On 21 May 2013, the European Parliament’s Economic and Monetary Affairs Committee (ECON) published a press release detailing its negotiating position with respect to certain elements of the proposed Recovery and Resolution Directive (RRD).

The negotiation position was approved by 39 votes to 6 and states that:

* the “bail-in” scheme should be operational by January 2016 at the latest;
* insured deposits (i.e. those below EUR 100,000) can never be subject to bail-in;
* uninsured deposits (i.e. those above EUR 100,000), can only be subject to bail-in “as a last resort”;
* funds from deposit guarantee schemes will not be capable of being diverted in order to help pay for bank resolution measures;
* taxpayer money can only be used to guarantee liabilities or assets, take a stake in a failing bank or institute temporary public ownership and only after all capital has been written down to zero and taxpayer intervention is necessary in order to:

* prevent “significant adverse effects on financial stability”; or
* protect the public interest;

* bank-financed resolution funds must be established at a national level and must have a capacity equal to 1.5% of the amount of deposits of the participating banks within 10 years of the entry into force of the RRD; and
* resolution funds will not be obliged to lend to each other.

The press release notes that the EU Council must now adopt its negotiating position, after which trialogue discussions between the Council, the Commission and the Parliament will commence.

The press release actually starts with the words: "Taxpayers and savers must be the last people called upon to bail out banks..." echoing Schäuble's point directly, and goes on to mirror other themes of his from above. Cyprus is mentioned in exactly the same way, for example.

The vote was 39 to 6.



But the story continues:

Legislative Update
Posted on May 31, 2013


Recovery and Resolution Directive


On 29 May 2013, the Presidency of the EU Council published its latest Compromise Proposal with respect to the Recovery and Resolution Directive (RRD). Additions to the original legislative proposal are underlined and additions to the most recent compromise proposal (dated 15 March 2013) are marked in bold.


EU Banking Union


On 30 May 2013, the EU Parliament updated its procedure file relating to the establishment of the single supervisory mechanism (SSM). It now appears that the SSM proposal will be considered at the Parliament’s plenary session to be held from 9-12 September 2013 instead of the 20-23 May session, as had previously been the case.

I notice that most of the underlined terms in the Compromise Proposal (changes from the draft Schäuble wrote about) pertain not to the meat of the proposal, but to who and what is/isn't covered. Immediately apparent is that he most recent changes (in bold) seem to refer directly to language that might be used to address the status of banks in a nation that had been established as part of the Union, but whose country later left!

There's plenty of room for other interpretations here, but I think the prospect of Britain leaving is being directly accommodated in new structures the EU creates. That might be significant either as a bluff, or a serious motion. It's certainly something to watch, though.

I'd sure love to know who suggested those underlined and boldfaced changes, though, and whether they were meant as a threat, or an appeasement.

To be complete, the changes could also refer to members joining the union, who would be excluded from the rules by the wording, but that seems less sensible to me so far.

[ProdigyofZen]

Re: What is capital?

If you register with the FT you get a certain number of free articles/month.

8 a month I believe.

[astonas]

Re: What is capital?

Good to know. I'll do that. Thanks, guys!

[nedtheguy]

Re: What is capital?

redacted

[astonas]

Re: What is capital?

I find that sometimes if you link in via Google News, you can bypass the firewall. So, in this case, I put in "Banking union must be built on firm foundations" into news.google.com and click the link through that page and don't get the firewall. From there, if I go to the homepage and try to read "Paris threatens EU-US talks as China trade war looms" it brings up the firewall. Go back to Google News and put that headline into it, click the FT link and presto - the story comes up. They must check if the linking is coming from a news aggregator and allow it if so?

Presumably so. I noticed that the go-through-google trick sometimes works on other sites as well, but some news sites seem to have wised up to it, and you still get blocked occasionally. I haven't really tried to test it exhaustively to find out why (maybe there are cookies on my computer that allow the site to know I'm a repeat offender?) Ah well.

But my intention wasn't necessarily to master the subversion of news organization payment structures, but rather to provide some commentary on what I hoped would be an illuminating article. Thanks to everyone for the help, and the tips on how to do so more easily in the future! Perhaps I will now have more to comment on. ;)

[jpatter666]

Re: What is capital?

And an interesting response.....

Admati and Hellwig, authors of The Bankers’ New Clothes, list the main objections levelled by the banking industry against their argument that banks should be required to hold much higher levels of capital — and demolish each one of them. “There is a large cost, and no benefit to society, from having banks funded with as much debt as they can”

http://bankersnewclothes.com/wp-cont...ues-June-3.pdf

[Chris Coles]

Re: What is capital?

Sorry to say, but as I see it there is a central misunderstanding about capital written into the article. You see, this all goes back to the origins of penny shares. They were called penny shares because that was how much they first cost to buy when issued. Companies would issue tens of millions of penny shares. Ten million pennies brought in £41,667; which was a lot of money once upon a time.

But the point I am making is the ISSUED share capital always remains EXACTLY the same amount and will be listed in the company accounts. Yes, the value of shares can increase when traded on a stock market; and again, yes, the company may indeed borrow more money based upon that new "Market" value. But the problem there is that if the market crashes; as it does from time to time...... the ONLY value the company accountant can rely on is the issued value on the books; because that is the only true value of the issued capital of the business.

It is bad enough when dealing with a normal trading business; but when it comes to banks, then they will do their level best to lend out every penny they can lay their hands on, and it is that aspect that has the potential for a sudden stop. If the market value of their shares drop suddenly; they are bankrupt. Period.

In accessing the trading accounts of any business; the only value of the underlying capital you can absolutely rely on is the issued share value.