China: It just got worse – more bad news and more policy mistakes: http://t.co/h6pwguOJl9 #China #PBoC #EndOfTheDollarBloc @bill_easterly
— Lars Christensen (@MaMoMVPY) September 1, 2015
China’s conundrum: Capital flight or deflation
China's conundrum: Selling FX reserves to support the yuan threatens deflation. But falling yuan fuels capital flight http://t.co/XGz6S4HPz6
— Colin Twiggs (@Colin_Twiggs) August 29, 2015
AND capital flight causes collapsing stock and real estate prices, which could lead to…… deflation.
Why we should not blame the ECB for low returns on German savings | Bruegel
From Guntram Wolff, originally published in Die Welt:
….what drives this decline in real interest rates? Real rates are determined by a whole set of economic factors, including growth prospects. Ultimately, it is economic performance that drives the return in investments. In a fast growing economy that is still building up its capital stock, real rates should be high as economic growth prospects are high. The opposite is true for an economy in a recessionary environment or an economy with already high capital stocks.
Read more at Why we should not blame the ECB for low returns on German savings | Bruegel.
Anat Admati: Regulatory reform effort is an unfocused, complex mess
Telling it like it is. Anat Admati is Finance and Economics Professor at Stanford GSB and coauthor of The Bankers’ New Clothes.
The financial system is not serving society well right now, certainly not as well as it can. It is a drag on the economy. Finance is fraught with governance problems. Free markets don’t solve these problems. Effective laws and regulation are essential.
……the regulatory reform effort is an unfocused, complex mess, both in design and in implementation. Some regulations end up as wasteful charades. They provide full employment and revolving opportunities for numerous lawyers, consultants, and regulators without producing enough benefits for society to justify the costs. Some of the complaints from the industry about these regulations have merit. In this category I put living wills, stress tests, risk weights, TLACs/cocos/bailinable debt (whatever the term for today), and liquidity coverage ratio. I am also concerned that, as implemented, central clearing of derivatives does not reduce, and may even increase, the concentration of dangerous risk. In all these contexts we see the pretense of action, the illusion of “science,” a false sense of safety, over-optimistic assessments of progress, and counterproductive distortions [emphasis added].
Lost in this mess are simpler, more straightforward regulations that would counter the incentives for recklessness and bring enormous benefits to society by making the system safer and healthier, as well as reducing unnecessary, unproductive risk that is a key source of system fragility, and the many distortions……..
Banks are not acting in society’s interests but their own. Not even primarily in the interests of shareholders but those of senior management. And they are doing their best to frustrate, obfuscate and capture regulators.
Finance is about money and power. Money and power can corrupt. So unlike in the airline business, in finance it is possible for the industry, regulators and politicians, to harm and endanger, to spin narratives and cover up the harm, and to be willfully blind, without any accountability. DoJ and the SEC must do their job, but they can’t deal with nonsense and capture.
So the biggest challenge in regulation is political. The details hardly matter if there is no political will. Unfortunately, most politicians put other objectives ahead of having a stable and healthy financial system. Ordinary people, meanwhile, may not be aware of what is going on or get confused by the spin. Not enough people understand why regulation is essential and what type of regulation makes sense.
What can be done? Here are some concrete ideas. First, increasing the pay of regulators may reduce revolving door incentives. Second, effective regulators might be industry veterans who are not inclined to go back. Third, we must try to reduce the role of money in politics.
To fix this, we need to break the feedback loop between Wall Street and government — the revolving door between regulators and the financial sector and between lobbyists and elected representatives. Otherwise the system will remain hijacked to enrich a few at the expense of the many.
Read more at Making Financial Regulations Work for Society: Comments by Anat Admati | Finance and Society INET Conference
CBA, ANZ, NAB and Westpac: The incredible shrinking big four banks | afr.com
Great article by Chris Joye:
Welcome to the world of that beautiful $140 billion behemoth, the Commonwealth Bank, which has inverted the axiom that there is a trade-off between risk and return. Years ago I highlighted a perversion embedded at the heart of our financial system: the supposedly lowest (highest) risk banks were producing the highest (lowest) returns. Normally it works the other way around.
…..contrary to some optimistic reports, the capital-raising game has only just begun.
The terrific news for shareholders is that this belated deleveraging will transform the majors into some of the safest banks in the world, which will be able to comfortably withstand a 1991-style recession, exacerbated by a 20 per cent decline in house prices.
In the past I have been critical of APRA’s failure to properly police Australia’s vastly-undercapitalized banking system but must now give them credit for their leadership towards creating a world-class system that will be able to withstand serious endogenous or exogenous economic shocks.
Shareholders face lower returns from reduced leverage but will benefit from improved valuations due to lower risk premiums and stronger, more stable, long-term growth.
Read more at CBA, ANZ, NAB and Westpac: The incredible shrinking big four banks | afr.com.
China: Deja vu all over again
The Shanghai Composite today found support at 3500 today after plunging more than 8% on Monday. The large divergence on 13-week Twiggs Money Flow continues to warn of selling pressure.
* Target calculation: 4000 – ( 5000 – 4000 ) = 3000
Japan’s Lost Decade
From Wikipedia:
The Japanese asset price bubble….. was an economic bubble in Japan from 1986 to 1991 in which real estate and stock market prices were greatly inflated. The bubble was characterized by rapid acceleration of asset prices and overheated economic activity, as well as an uncontrolled money supply and credit expansion. More specifically, over-confidence and speculation regarding asset and stock prices had been closely associated with excessive monetary easing policy at the time.
By August 1990, the Nikkei stock index had plummeted to half its peak by the time of the fifth monetary tightening by the Bank of Japan (BOJ)…..the economy’s decline continued for more than a decade. This decline resulted in a huge accumulation of non-performing assets loans (NPL), causing difficulties for many financial institutions. The bursting of the Japanese asset price bubble contributed to what many call the Lost Decade.
“…uncontrolled money supply and credit expansion….overheated stock market and real estate bubble.” Sound familiar? It should. We are witnessing a re-run but this time in China. Wait, there’s more…..
…..At the end of August 1987, the BOJ signaled the possibility of tightening the monetary policy, but decided to delay the decision in view of economic uncertainty related to Black Monday (October 19, 1987) in the US.
…..BOJ reluctance to tighten the monetary policy was in spite of the fact that the economy went into expansion in the second half of 1987. The Japanese economy had just recovered from the “endaka recession” ….. closely linked to the Plaza Accord of September 1985, which led to the strong appreciation of the Japanese yen.
…..in order to overcome the “endaka” recession and stimulate the local economy, an aggressive fiscal policy was adopted, mainly through expansion of public investment. Simultaneously, the BOJ declared that curbing the yen’s appreciation was a “national priority”……
Global stock market crash leads to prolonged monetary easing…… aggressive expansion of public investment to stimulate the domestic economy…..central bank efforts to curb appreciation of the currency. We all know how this ends. We’ve seen the movie before.
It’s like deja-vu, all over again. ~ Yogi Berra
APRA confirms further capital adequacy measures
From Robin Christie:
The Australian Prudential Regulation Authority (APRA) has confirmed that the country’s largest banks will face increased capital adequacy requirements for residential mortgage exposures – and hasn’t ruled out further rises.
The regulator made it clear yesterday that the new rules would be an interim measure based on the Financial System Inquiry’s (FSI) recommendations – and that it was keenly awaiting guidance from the Basel Committee on Banking Supervision before making any further changes.
The new measures, which come into effect on 1 July 2016, mandate that authorised deposit-taking institutions (ADIs) that are accredited to use the internal ratings-based (IRB) approach to credit risk must increase their average risk weight on Australian residential mortgage exposures to at least 25 per cent. According to APRA, the current average risk weight figure sits at around 16 per cent….
This is a welcome first step. Increases in bank capital will improve economic stability. Even at 25 percent, however, a capital ratio of 10% would mean that banks are holding 2.5 percent capital against residential mortgages. Further increases over time will be necessary.
Read more at APRA hints at further capital adequacy measures.
China’s stock market falling off a cliff: Why, and why care? | Alicia García-Herrero at Bruegel.org
Great insight from Alicia García-Herrero:
….The need for Chinese corporations and banks to avail themselves of fresh equity cannot be underestimated. On the one hand, corporate debt has grown sixfold from 2005 levels. On the other hand, Chinese banks are not only heavily exposed to these corporates, being still their main source of financing, but also to local governments whose huge borrowing from banks is starting to be restructured. To make a long story short, China’s governments needed a bull stock market to transfer part of the cost of cleaning up its corporates’ and banks’ balance sheets from the state to private investors, including foreigners. The PBoC danced to the Government’s tune, easing monetary policy since November last year. This was done through several interest rate cuts and by lowering the liquidity ratio requirements. The problem with all of this liquidity is that it only fueled additional leveraging, including for gambling on the stock market…..
The sudden collapse of the Chinese stock market had two triggers. First, the was a wave of profit taking after the Shanghai benchmark index broke through 5 000 in early June and doubts emerged about further easing from the PBoC. At that very same moment, China’s securities regulator announced measures to cool down the market, which amounted to banning brokerage firms from providing unregulated margin funding to investors. This was more of a shock to the system than one might imagine, as margin financing in China is much larger than in other stock markets.
Japan had zombie banks, looks like China could end up with a zombie stock market.
Read more at China's stock market falling off a cliff: Why, and why care? | Alicia García-Herrero at Bruegel.org.
Bank share prices tipped to decline
Chris Joye at the AFR warns that increased capital requirements could cause an 18.5 percent fall in bank stocks:
….APRA warns that because the report makes several assumptions that are unrealistically favourable to the majors, and the majors’ CET1 ratios have fallen behind global peers since June 2014, it believes they “are likely to need to increase their capital ratios by at least 200 basis points … to be comfortably positioned in the fourth quartile”.
In dollar terms, UBS’ No. 1 ranked analyst Jonathon Mott estimates that this represents a CET1 shortfall of about $24 billion today, accounting for the extra equity the majors have started sourcing since June 2014 (the short-fall would otherwise have been $30 billion). That’s consistent with the lower bound of estimates I previously canvassed here.
Yet this number may be a low-ball for two reasons. First, APRA has yet to respond to the FSI’s recommendation of introducing a minimum average residential mortgage “risk-weighting” of between 25 per cent and 30 per cent. Second, the majors are likely to be slugged with higher risk-weights on their non-residential assets as a consequence of the new Basel 4 rules.
UBS’ research implies that the combined impact of this will be another $16 billion in CET1 on top of the $24 billion shortfall, which gives a total CET1 capital deficiency of $40 billion.
The Australian Financial Review’s Chanticleer column says the majors will only be given 12 months to boost CET1 in response to APRA’s looming decision on residential mortgage risk-weights, which the regulator says it will make “shortly”.
Bank share prices tipped to decline
From a shareholders’ perspective, higher equity means lower leverage and associated returns. Whether that translates into a fall in the majors’ valuations is an open question and depends on whether reduced returns on equity are offset by repricing of deposits and loans and cheaper overall funding costs. As I have explained before, there are arguments for and against. My base-case is that we see a 200 basis point dilution in returns on equity from current world-beating marks that results in a circa 18.5 per cent reduction in major bank valuations.
I would expect APRA to soften the blow by phasing in increased capital ratios and risk-weighting of residential mortgages over time. The impact this will have on valuations depends on several factors. Lower perceived risk could lead to lower cost of funding as well as higher earnings multiples. Also, a BIS study has shown that banks with stronger balance sheets are likely to experience stronger growth — which would again raise the earnings multiple. But I agree with Joye that we are likely to witness some softening of major bank stocks.
Read more at Big banks still short $40b on APRA's terms | afr.com.
APRA considers two per cent capital adequacy increase
by Robin Christie | 14 Jul 2015
The Australian Prudential Regulation Authority (APRA) has stated that the major banks would need to increase their capital adequacy ratios by at least two per cent to meet Financial System Inquiry (FSI) recommendations.
APRA has been comparing the capital position of the Australian major banks against a group of international counterparts, and the results of this study, released today, have led to the two per cent figure being mooted.
The study was implemented as a direct response to the FSI final report’s first recommendation, that APRA should “set capital standards such that Australian authorised deposit-taking institution [ADI] capital ratios are unquestionably strong”. This would mean making sure that Australian ADIs sit in the top quartile of internationally-active banks in capital adequacy terms.
….the statement adds that APRA is committed to ensuring that any capital adequacy requirement improvements occur “in an orderly manner”. This process would take into account Australian ADIs’ ability to manage the impact of any changes “without undue disruption to their business plans”.
While APRA hasn’t made a decision on whether it will go as far as mandating a two per cent increase in capital adequacy ratios…. it has stated that Australian ADIs should be well placed to accommodate its directives over the next few years – “provided they take sensible opportunities to accumulate capital”.
Bear in mind that capital adequacy ratios are measured against risk-weighted assets, where asset values are adjusted for the perceived risk of default. Australian banks have historically used risk weightings as low as 15% for residential mortgages compared to 50% in the US. That means that a bank with a capital ratio of 10% would only hold 1.5% capital against residential mortgages. And a 2% increase, to a capital ratio of 12%, would only increase capital cover to 1.8%. Revision of risk weightings is more important than an increase in the capital ratio, especially given Australia’s precarious property market.
Read more at APRA considers two per cent capital adequacy increase.