Capital Requirements for Banks Hotly Debated

Ben Chu writes:  A senior official at the Bank of England has been accused of misleading the public about the safety of UK banks.

He cited Bank of England estimates that a 1 percentage point increase in capital requirements across the board could knock around 0.6 per cent off GDP. “The costs will be borne by real borrowers in higher costs of funds and real savers in lower returns,” he warned. But Mr Brazier’s remarks drew a strong rebuttal from Professor Anat Admati of Stanford University, a widely acknowledged expert on the banking sector.

“I am alarmed by Mr Brazier’s speech because it confirms that important policy regarding financial stability is based on flawed claims and flawed research,” she said.

Ms Admati rejected the Bank’s estimate of the wider economic cost of banks using more capital and said one reason banks might find it more expensive to fund their balance sheets with more equity and less debt was because their de facto public subsidies from the taxpayer, such as being “too big to fail” and the tax deductability of debt, would have been eroded.

“It is disturbing that the Bank’s head of financial stability seems to be more concerned with supporting the banks by making flawed assertions that contradict fundamental principles of corporate funding,” she said.

The row comes at a time when the Bank is under serious pressure to reconsider its capital rules. The position of Mr Brazier, who was appointed to his current position last year, seems to be in line with those of the Bank’s Governor, Mark Carney. Mr Carney has repeatedly sought to assure bankers that there will be no additional capital requirements made on them in the coming years. Referring to the international “Basel” agreements on capital standards sealed in 2011, Mr Carney insisted in Shanghai last month: “There will be no Basel IV”.

In his new book The Age of Alchemy, Lord King takes a tough line on capital, saying it would be “a good start” for banks to have a minimum ratio of equity to total assets of 10 per cent. The Bank is currently planning to require them to have equity worth only between 3 and 4 per cent of total assets. For her part, Ms Admati says banks should have 20 per cent buffers.

“Their hatred of equity only confirms that the subsidies are substantial to their business model – but the subsidies come from the public,” said Ms Admati.

Focus on Finance

“The world has largely exhausted the scope for central bank improvisation as a growth strategy,” says Larry Summers, Harvard economist and advisor to Presidents. 

The new normal is low growth, rising inequality, political dysfunction and sometimes social tension.  Central banks have intervened.  Technical innovation has been transformative. And yet we are at a fork in the road.  Great New York Yankees baseball catcher Yogi Berra was fond of saying, “When you come to a fork in the road, take it.” 

Unfortunately we can’t have both forks.  Either we will get higher inclusive growth and genuine financial stability.  r we will get mired in lower growth with periodic recessions and the return of financial instability. 

We need to make better choices as households, companies, and governments.

WHen other policy makers were paralyzed by the world economic crisis in 2008-9, central banks stepped up.  The created a largely artificial growth path but the underlying engine of economic prosperity was not re-vamped. 

Central banks’ ability to pull new rabbits out of a hat is shrinking. 

The 17th century saw the creation of the first central banks in Sweden and then England.

Today the US Federal Reserve is the most powerful central bank in the world, but it was only created following a financial crisis in 1913.   The Fed’s mission is to “provide the nation with a safe, flexible, stable monetary ans financial system.”

The European Central Bank, representing 19 nations, is the second most powerful. It began to operate in 1999. 

We will present a series of articles on central banks.  They are based on Mohammed El Erian’s recent book, “The Only Game in Town: Central Banks, Instability and the Next Collapse.”

International Women’s Day

Women have seen only “marginal improvements” in the world of work in the past 20 years, according to a global study.

The International Labour Organization (ILO) said the difference in the employment rate between men and women had decreased by 0.6% since 1995.

In countries where women access work more easily, the quality of their jobs “remains a matter of concern”.

The findings come as events take place to mark International Women’s Day.

The board of governors of the European Bank for Reconstruction and Development (EBRD) approved China’s application for membership. China is, of course, already a shareholder in several global and regional development institutions, but the EBRD is different in its focus on private sector development and explicit promotion of democracy and a market economy. Membership is part of much more ambitions engagement of China in global finance.

The European Union will likely struggle to find a balance in relations with China this year, after initiatives such as participating in the Beijing-sponsored Asian Infrastructure Investment Bank contributed to a warming of ties last year with the world’s second-largest economy. On Feb. 15, the head office of the EU in Brussels was surrounded by about 5,000 demonstrators wearing hard hats and carrying banners and signs, who accused China of dumping steel and demanded the protection of jobs in Europe.

the US Dollar is close to printing 2016 lows. We have a scenario on our hands that is uniquely different to 2015 at the same time of year. Last year, the US Dollar was a run-away train into the Ides of March, and then the Fed came out to tell markets that the Fed would not harm the world with a Strong Dollar on their own accord.

The future-bearing potential of the rapprochement of Europe and the BRICS as a spearhead of global governance reform in a multipolar world. However, given the current global political setup the Euro-BRICS connection does not live up to its full potential.

Britain’s membership of the European Union reinforces the country’s economic “dynamism” but leaves it more exposed to financial shocks, Bank of England governor Mark Carney said.  Carney expressed the view in a letter to the head of the Treasury Select Committee before facing questions from the cross-party panel of lawmakers on Britain’s relationship with the EU ahead of June’s referendum on whether the country should remain part of the EU.

Alexander Friedman writes: Central bank policies have moved from supporting the markets to potentially destabilizing them. Now markets are turning to structural reform and fiscal policy for assistance. In this light, current price movements should be viewed through the spectrum of geopolitics. And it is not a nice view.

Nowhere is this more evident than in the oil markets, where prices have collapsed, with both Brent and Crude now hovering around the $30-per-barrel level.  In January, the correlation between crude oil prices and the S&P 500 reached the highest level since 1990.

It has become increasingly clear that supply dynamics, rather than falling demand, explain the drop from $110/barrel since the summer of 2014.

These supply dynamics are shaped by politics. Daily headlines about potential coordinated measures by the key oil-producing countries fuel oil-price volatility and define risk appetite across financial markets. Yet the politics is so confused that coordination appears unlikely, at best; the Iranian oil minister recently described a potential OPEC production freeze as a “joke.”

Currency policy remains confused, while newly introduced (and soon withdrawn) stock-market circuit breakers have accelerated market falls, as investors try to sell shares before liquidity disappears. Moreover, purchases by state-owned financial institutions, together with bans on sales by large institutional shareholders, cannot remain permanent features if the market is to be truly free.

Labile politics are increasingly driving outcomes in other emerging markets as well. In Brazil, the government struggles to balance its populist agenda with lower commodity prices, dwindling growth, and persistent inflation.

In Russia, too, politics has aggravated the negative oil-price shock. Western sanctions have contributed to an already slowing growth trajectory, and are threatening Russia’s ability to raise debt capital in global markets. The ruble has plummeted 130% since 2014 began, and GDP in 2015 contracted by 3.7%.

Yet Russia is a star performer compared to Venezuela, where President Nicolás Maduro’s government has overseen the economy’s total disintegration.

In Europe, the efficacy of the European Central Bank’s monetary policies is waning as the political scene becomes increasingly fragile.

Meanwhile, the migration crisis threatens Germany’s government; splits are now deepening within Chancellor Angela Merkel’s party.

In Southern Europe, Spain’s recent elections were inconclusive, and the absence of a stable government could derail an economic recovery that gained traction in 2015.

Turning to Japan, the strength in equities since Prime Minister Shinzo Abe took office has been founded on his “Abenomics” strategy’s “three arrows”: monetary stimulus, fiscal stimulus, and structural reforms. The Bank of Japan has launched one arrow, expanding the monetary base to ¥80 trillion ($710 billion). But momentum has faded considerably, as investors wait for the structural reforms needed for sustained improvement in economic, and market, fundamentals.

Financial markets, which seek stability and predictability, are struggling to find it in the politics of the world’s largest economy.

History may not repeat itself, but let’s hope it finds its rhyme. Back in the 1990s, the US economy stabilized and then surged forward, driven by accelerating productivity and abetted by sound monetary and fiscal policy. But economies may prove to be easier to mend than today’s dysfunctional politics, which may be part and parcel of the “new normal.”

John Wiliams of the Sa Francisco Federal Reserve comments:The Federal Reserve has a dual mandate: maximum employment and price stability. We want everyone who wants a job to be able to find one and for inflation to average 2% per year.

Unemployment will never be zero, because in any well-functioning economy, people leave jobs and new people enter the workforce. Economists use the term “natural rate of unemployment” to describe the optimal rate for an economy at full health. It’s hard to know exactly what the number is, but I put the natural rate at about 5%.

We dipped just below that, to 4.9%, in January. I expect the unemployment rate to continue to come down a bit further, reaching the mid-4s later this year. This is a reflection of steady improvement in a labor market that has fully recovered from the recession and its aftermath, when we saw a peak of 10%.

A further sign of the health of the labor market is that more people are quitting their jobs – indicating they feel confident that they’ll find another – and they’re probably right: Job vacancies are at the highest levels since they started collecting the data in 2000. We added more than 2½ million jobs in 2015. All in all, we have reached or are close to maximum employment across a broad range of markers.

The Fed sets a target of 2% average inflation. Many people think that Fed policymakers’ concern lies disproportionately with inflation that’s too high. They think we view inflation lower than 2% as sort of “not great,” but see inflation above 2% as catastrophic. That’s not the case. In my view, inflation somewhat above 2% is just as bad as the same amount below.

Despite recent financial volatility, my overall outlook for the U.S. and the global economy remains unchanged. There is plenty of concern about China’s slower pace, but as I said last year, this largely reflects a pivot from a manufacturing-based economy to one driven by domestic consumption and services – the exact engines that are currently powering U.S. growth (Williams 2015).

Despite the Sturm und Drang of international and market developments, the U.S. economy is, all in all, looking pretty good.

Brexit  Wolfgang Schäuble was on a mini-roadshow in London, appearing at a couple of events to push the anti-Brexit case with characteristic toughness but uncharacteristic emotion.

First, the German finance minister appeared alongside George Osborne at a panel. Asked about his reaction should Britain decide to leave, he said: “We would cry … and I hope that we will not.”

Then, at a conference organized by the German British Forum, he urged Britain to go for “splendid integration” rather than “splendid isolation.”

“If the U.K. were to leave the EU, it would be very dangerous for the European Union, it would weaken the European Union … I can’t see that it’s in Britain’s interest for the EU to be weakened,” Schäuble said. “So please don’t.”

“Britain’s future lies in Europe,” he pleaded to an audience of British and German grandees before ending with a very British exhortation: “Go on, lead Europe!”

The prime minister’s biggest headache on Brexit is not Boris Johnson but “Red Jez”, as some papers call the left-wing leader of the Labour Party, according to professor Matthew Goodwin writing for POLITICO. His thesis is that, in order to win the referendum, Cameron needs to win over voters that are not natural Conservative supporters.

Changing Securitization in Europe  Four trade associations have issued a paper pushing for a swift reform of the moribund securitization market.

The four, the Association for Financial Markets in Europe (AFME), the European Fund and Asset Management Association (EFAMA), the International Capital Market Association (ICMA) and Insurance Europe, are broadly supportive of the European Commission’s efforts to revive the market but want more clarity and details on issues such as asset-backed commercial paper, disclosure and third-country deals.

Remember: The US subprime mortgage crisis began with the securitization of mortgages.

UK Life Insurers   The Financial Conduct Authority is concerned about the treatment of long-term customers who wanted to make changes to their policies. Here’s Sky News: “Prudential, Old Mutual, Abbey Life, Scottish Widows, Countrywide and Police Mutual are to be investigated by the Financial Conduct Authority.

“The FCA has been monitoring whether insurers have treated customers who are locked into pensions and other savings plans fairly, compared with new customers. Tracey McDermott, the FCA’s acting chief executive, said: ‘The practices at some firms appear to have been poor.’

Andrew Sheng-and Xiao Geng write: China’s ability to maintain stability depends on a multitude of interrelated factors, such as low productivity growth, declining real interest rates, disruptive technologies, excess capacity and debt overhangs, and excess savings. In fact, the current battle over the renminbi’s exchange rate reflects a tension between the interests of the “financial engineers” (such as the managers of dollar-based hedge funds) and the “real engineers” (Chinese policymakers).

Foreign-exchange markets are, in theory, zero-sum games: the buyer’s loss is the seller’s gain, and vice versa.

Nowadays, financial engineers increasingly shape the exchange rate through financial transactions that may not be linked to economic fundamentals. Because financial markets notoriously overshoot, if the short-sellers win by pushing exchange rates and the real economy into a low-level equilibrium, the losses take the form of investment, jobs, and income. In other words, financial engineers’ gain is real people’s pain.

In order to achieve these gains, financial engineers use the media to influence market behavior.

China’s growth slowdown and the rise of non-performing loans are being discussed as exclusively negative developments. But they are also necessary pains on the path to supply-side reform aimed at eliminating excess capacity, improving resource efficiency, and jettisoning polluting industries.

China’s authorities have long understood that a stable renminbi exchange rate is critical to national, regional, and global stability. Indeed, that is why they did not devalue the renminbi during the Asian financial crisis. They saw what most analysts missed: leaving the US dollar as the main safe-haven currency for global savings, with near-zero interest rates, would have the same deflationary impact that the gold standard had in the 1930s.

In the face of today’s deflationary forces, however, real engineers in the world’s major economies have been unwilling or unable to reflate. The United States, the world’s largest economy, will not use fiscal tools to that end, owing to domestic political constraints. Europe’s unwillingness to reflate reflects Germany’s deep-seated fear of inflation (which underpins its enduring commitment to austerity). Japan cannot reflate because of its aging population and irresolute implementation of Prime Minister Shinzo Abe’s economic plan, so-called Abenomics. And China is still paying for the excessive reflation caused by its CN¥4 trillion ($586 billion) stimulus package in 2009, which added over CN¥80 trillion to its own debt.

Meanwhile, the consequences of financial engineering are intensifying. Zero and negative interest rates have not only encouraged short-term speculation in asset markets and harmed long-term investments; they have also destroyed the business model of banks, insurance companies, and fund managers.

Financial engineers outperformed the real economy only with the support of super-financial engineers – that is, central banks. Initially, balance-sheet expansion – by $5 trillion since 2009 – provided banks with the cheap funding they needed to avoid failure. But bank deleveraging (brought about by stiffer regulatory requirements), together with negative interest rates, caused financial institutions’ equity prices to fall, leading to further pro-cyclical destruction of value through price deflation, increasing illiquidity, and crowded exits.

Past experience has taught China’s real engineers that the only way to escape deflation is through painful structural reforms – not easy money and competitive devaluation.

The US dollar is a safe haven, but savers in need of liquidity still lack an impartial lender of last resort. Depositing in reserve currencies at near-zero interest rates makes sense only if the banker is not funding financial speculation against the depositor.

China’s G-20 presidency this year offers an important opportunity to emphasize that renminbi stability is important not only for China, but also for the global financial system as a whole. If the US dollar enters into another round of revaluation, the only winners will be financial engineers.

Kemal Dervis writes: The Economist recently asked of monetary policymakers. Stephen Roach has called the move by major central banks – including the Bank of Japan, the European Central Bank, and the Bank of Sweden – to negative real (and, in some cases, even nominal) interest rates a “futile” effort that merely sets “the stage for the next crisis.” And, at the February G-20 finance ministers meeting, Bank of England Governor Mark Carney reportedly called these policies “ultimately a zero-sum game.” Have the major advanced economies’ central banks – which have borne the burden of sustaining anemic post-2008 recoveries – really run out of options?

It certainly seems so. Central-bank balance sheets have swelled, and policy rates have reached their “near zero” lower bounds.

But policymakers have one more option: a shift to “purer” fiscal policy, in which they directly finance government spending by printing money – a so-called “helicopter drop.” The new money would bypass the financial and corporate sectors and go straight to the thirstiest horses: middle- and lower-income consumers. The money could go to them directly, and through investment in job-creating, productivity-increasing infrastructure. By placing purchasing power in the hands of those who need it most, direct monetary financing of public spending would also help to improve inclusiveness in economies where inequality is rising fast.

Helicopter drops are currently proposed by both leftist and centrist economists.

Even with such an approach, however, major central banks would have to coordinate their policies.

Success also hinges on the simultaneous pursuit of fiscal expansion worldwide, with each country’s efforts calibrated according to its fiscal space and current-account position. The expansion should finance a global program of investment in physical and human infrastructure, focusing on the two key challenges of our time: cleaner energy and skills for the digital age.

Economic orthodoxy and independent actions have clearly failed. It is time for policymakers to recognize that innovative international policy cooperation is not a luxury; sometimes – like today – it is a necessity.

Ishac Diwan writes:  Five years after the Arab Spring uprisings began, Egypt, Jordan, Morocco, and Tunisia have achieved reasonable levels of political stability. Yet economic growth remains tepid.

Market economies are relatively new to the Middle East and North Africa, having arisen only after the 1980s, when the model of state-directed economic growth collapsed under the weight of its inefficiencies (and resulting debt). Unlike Latin America or Eastern Europe, however, Arab countries liberalized their economies without liberalizing their politics.

As a result, even as the reforms of the 1990s rolled back the state’s economic role – in Egypt, state spending fell from 60% of GDP in 1980 to 30% of GDP in the 1990s – politics continued to shape markets. With economic privileges doled out in a way that favored firms were able to acquire virtual monopolies over entire liberalized economic sectors.

In Egypt, for example, the firms of 32 businessmen closely connected with then-President Hosni Mubarak received in 2010 more than 80% of the credit that went to the formal private sector and earned 60% of the sector’s overall profits, while employing only 11% of the country’s labor force. In Tunisia, former President Zine El Abidine Ben Ali’s cronies received 21% of all private-sector profits in 2010, though their firms employed only 1% of Tunisia’s labor force.

Unsurprisingly, this system generated only modest growth.

And it was not only traditional rent-filled sectors, such as real estate or natural resources, that failed to reach their growth potential. In tradable sectors, such as manufacturing and utilities, rents were created through non-tariff protection and subsidies, leading to anemic export growth.

The result was a dearth of jobs in the formal sector. Intensifying social dissatisfaction was met with rising levels of repression.

The governments that emerged from the Arab Spring’s wreckage inherited a broken system of closed deals. Inadequate property-rights protection is impeding investment, but moving to fair and well-enforced rules is not a realistic prospect in the current environment, given the petty corruption of an underpaid bureaucracy and the polarized political environment.

These countries could try to replicate Turkey’s economic success in 2000-2010, when a political alliance between the ruling party and a broad group of dynamic small and medium-size enterprises (SMEs) contributed to a tripling of exports.

Here, Morocco and Jordan have had some success, with their monarchies proving capable of managing elites who offer both political acquiescence and economic sustenance. Tunisia could take a page out of Morocco’s playbook, expanding its export sector by attracting foreign direct investment, while opening up its domestic services sector to local SMEs. For its part, Egypt is relying on public and private firms close to its army, together with finance from the Gulf Cooperation Council, to support its economy.

For Morocco and Tunisia, the convergence of interests between moderate Islamists and liberals offers a ray of hope. But such hope seems to be lacking for the moment in Egypt and elsewhere in the region.