Compulsory and tax-advantaged superannuation has the effect of inflating funds flowing into the financial sector, said the submission [to the Financial System Inquiry].
“We note an emerging body of research concluding that beyond a threshold level, financial sector size and growth have a negative association with stability, economic growth and productivity,” Regnan said.
Read more at Murray must target 'intermediation' – InvestorDaily.
From the Economist:
Five devastating slumps—starting with America’s first crash, in 1792, and ending with the world’s biggest, in 1929—highlight two big trends in financial evolution. The first is that institutions that enhance people’s economic lives, such as central banks, deposit insurance and stock exchanges, are not the products of careful design in calm times, but are cobbled together at the bottom of financial cliffs. Often what starts out as a post-crisis sticking plaster becomes a permanent feature of the system. If history is any guide, decisions taken now will reverberate for decades.
This makes the second trend more troubling. The response to a crisis follows a familiar pattern. It starts with blame. New parts of the financial system are vilified: a new type of bank, investor or asset is identified as the culprit and is then banned or regulated out of existence. It ends by entrenching public backing for private markets: other parts of finance deemed essential are given more state support. It is an approach that seems sensible and reassuring. But it is corrosive. Walter Bagehot, editor of this newspaper between 1860 and 1877, argued that financial panics occur when the “blind capital” of the public floods into unwise speculative investments. Yet well-intentioned reforms have made this problem worse.
…..To solve this problem means putting risk back into the private sector. That will require tough choices. Removing the subsidies banks enjoy will make their debt more expensive, meaning equity holders will lose out on dividends and the cost of credit could rise. Cutting excessive deposit insurance means credulous investors who put their nest-eggs into dodgy banks could see big losses…..
Read more at Financial crises | The Economist.
Stephanie Armour and Ryan Tracy discuss the new leverage ratio that the eight biggest US lenders will be required to meet:
The eight bank-holding companies would have to hold loss-absorbing capital worth at least 5% of their assets to avoid limits on rewarding shareholders and paying bonuses, and their FDIC-insured bank subsidiaries would have to keep a minimum leverage ratio of at least 6% or face corrective actions. That is higher than the 3% agreed upon under global standards, which U.S. regulators have seen as too weak.
[FDIC Chairman Maurice] Gruenberg said leaving the leverage ratio at 3% for large banks “would not have meaningfully constrained leverage during the years leading to the crisis.” He said the rule “may be the most significant step we have taken to reduce the systemic risk posed by these large complex banking organizations.”
Banks are pushing back against the new ratios required by the Fed, FDIC and the Office of the Comptroller of the Currency.
Banks have balked at the leverage ratio, saying it will curtail lending and saddle them with more costs that leave them at a competitive disadvantage against foreign banks with lower capital requirements. Banks will have to hold that capital as protection for every loan, security and asset they hold, not just those deemed risky.
As a general rule, share capital is more expensive than debt, but that may not be the case with highly leveraged banks if you remove the too-big-to-fail taxpayer subsidy. Improved capital ratios would lower the risk premium associated with both the cost of capital and the cost of debt, offering a competitive advantage over foreign banks with higher leverage.
I would like to see APRA impose a similar minimum on Australia’s big four banks which currently range between 4% and 5%.
Read more at Big Banks to Get Higher Capital Requirement – WSJ.com.
From a speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, at the New York Stock Exchange, New York, 26 March 2014:
How do we get to the end of the tunnel?
At the European level, the most important project is the banking union. The banking union is most certainly the biggest step since the introduction of the euro. And it is the most logical step to take. A single currency requires integrated financial markets and this includes the supervision of banks.
Consequently, one of the pillars the banking union rests upon is a Single Supervisory Mechanism – that is European bank supervision for the largest banks. Centralising supervisory powers in such a way can foster a comprehensive and unbiased view upon banks. It also enables policy action that is not held hostage by national interests. Thus, it will contribute to more effective supervision and better cross-border cooperation and coordination.
Read more at Andreas Dombret: What is going on in Europe? The view from within.
Lars Christensen at The Market Monetarist writes:
….. sharply increased geo-political tensions in relationship to Putin’s military intervention on the peninsula of Crimea has clearly shocked foreign investors who are now dumping Russian assets on large scale. Just Monday this week the Russian stock market fell in excess of 10% and some of the major bank stocks lost 20% of their value on a single day.
In response to this massive outflow the Russian central bank – foolishly in my view – hiked its key policy rate by 150bp and intervened heavily in the currency market to prop up the rouble on Monday. Some commentators have suggested that the CBR might have spent more than USD 10bn of the foreign currency reserve just on Monday. Thereby inflicting greater harm to the Russian economy than any of the planned sanctions by EU and the US against Russia.
By definition a drop in foreign currency reserve translates directly into a contraction in the money base combined with the CBR’s rate hike we this week has seen a very significant tightening of monetary conditions in Russia – something which is likely to send the Russian economy into recession (understood as one or two quarters of negative real GDP growth).
Read more at Recession time for Russia – the ultra wonkish version | The Market Monetarist.
Sober Look highlights the sharply declining ratio of commercial bank loans and leases to bank deposits.
Its only when we examine the detail, however, that we note cash reserves have ballooned in the last 10 years. And most of those cash reserves are deposits at the Fed which now (post-GFC) earn interest. Adjust total deposits at commercial banks, for the excess reserves deposited back with the Fed, and the current ratio of 1:1 looks a lot healthier.
As I pointed out in November, most new money created by the Fed QE program is being deposited straight back with the Fed as excess reserves. We need to adjust bank deposits for this effect to obtain a true reflection of bank lending activity.
Low interest rates clearly boost corporate profits. The inverse relationship is evident from the strong profits recorded in the 1950s, when corporate bond rates were lower than at present, and also the big hole in profits in the 1980s, when interest rates spiked dramatically during Paul Volcker’s reign at the Fed.
The outlook for inflation is muted and the rise in interest rates likely to be gradual over several years, rather than a sharp spike, if the Fed has its way.
Question received from CG about the impact of QE and Fed taper:
I’m not arguing against the data presented on the graph, but if true that most of the QE bond purchases are being parked by banks in interest-bearing, excess reserve deposits at the Fed, why do the markets get spooked every time there are whispers that the Fed is going to reduce QE?
The comment CG is referring to:
Currently, there is evidence of expansive monetary policy from the Fed, but the overall impact on the financial markets is muted. Most of the QE bond purchases are being parked by banks in interest-bearing, excess reserve deposits at the Fed. The chart below compares Fed balance sheet expansion (QE) to the increase in excess reserve deposits at the Fed.
A classic placebo effect, the Fed is well aware that the major benefit of their quantitative easing program is psychological: there is little monetary impact on the markets.
My answer:
The markets have no real reason to fear a QE taper. I think this is more psychological than physical. The current mind-set is:
If the Fed begins to taper, that marks the end of the bull market in bonds. Rising bond yields and higher long-term interest rates may slow industry investment and recovery of the housing market and this would be bad for the economy.
In other words, they still have a bearish outlook. At some point they will shift to the counter-argument:
QE taper and rising interest rates indicate Fed faith in the recovery and are a bullish sign for stocks. It also means the economy is reverting to a sustainable path.
The bottom-line is that markets are driven as much by emotion as by logic.
From FIIG Newswire:
National Australia Bank Limited (ASX:NAB) has announced to the ASX the issue of a listed, floating rate convertible preference share (\”CPS II\”) with an indicative dividend of 325 to 340 bps over the bank bill swap rate. NAB is seeking to raise $750,000,000 for general corporate purposes. APRA has confirmed that the CPS II will count as additional Tier 1 Capital, supporting the NAB\’s regulatory capital requirements.
A welcome move to see the big four banks raising more Tier 1 capital. My view is that TBTF banks should have a minimum leverage ratio of 10 percent — more than double the current 4 to 5 percent.
Read more at FIIG Announcement.
From an address by William C. Dudley, President of the NY Fed, to the Global Economic Policy Forum, November 8, 2013:
There is evidence of deep-seated cultural and ethical failures at many large financial institutions. Whether this is due to size and complexity, bad incentives or some other issues is difficult to judge, but it is another critical problem that needs to be addressed. Tough enforcement and high penalties will certainly help focus management’s attention on this issue. But I am also hopeful that ending too big to fail and shifting the emphasis to longer-term sustainability will encourage the needed cultural shift necessary to restore public trust in the industry.
Dudley calls for increased capital requirements to reduce the risk of failure as well as more robust procedures to reduce the impact of a single large failure:
The major initiative here is the single point of entry framework for resolution proposed by the Federal Deposit Insurance Corporation. Under this framework, if a financial firm is to be resolved under Title II of the Dodd-Frank Act, the FDIC will place the top tier bank holding company into receivership and its assets will be transferred to a bridge holding company. The equity holders will be wiped out and sufficient long-term unsecured debt will be converted into equity in the new bridge company to cover any remaining losses and to ensure that the new entity is well capitalized and deemed creditworthy. Subsidiaries would continue to operate, which should limit the incentives for customers to run. By assigning losses to shareholders and unsecured creditors of the holding company and transferring sound operating subsidiaries to a new solvent entity, such a “top-down” resolution strategy should ensure continuity with respect to any critical services performed by the firm’s subsidiaries and this should help limit the magnitude of any negative externalities.
Read more at Ending Too Big to Fail | The Big Picture.
