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Following the publication of a document on Islamic Finance (IF) by Austrade this week, perhaps we may get something serious in the way of development of this area in Australia.

Interestingly, the Trade Minister, in releasing the document, announced the release of a new product by Westpac – I wonder when Westpac will get around to announcing it. I would not find anything on their website. My guess is that this is just a toe in the water, because if they expected it to be a significant part of their business, they would have to make an ASX release about it. In that, I think they are right. A single specialised product is not going to be big in the context of and institution that size. That said, getting some credibility and experience will be a good thing.

For those interested in the area, a full read of the Austrade publication would be a useful thing. It provides a decent discussion of the IF market (although some of the data seems a little out of date as market growth has been hit by the Dubai problems). The issues identified in it are similar to the ones I identified a while back – the tax and regulatory structures in Australia need to be changed to remove the artificial impediments, find or develop appropriately qualifies Islamic scholars and we need to increase the knowledge base of banking professionals in Australia.

None of this is impossible – the regulatory stuff can be done quickly by essentially copying (at the State level) what Victoria has done and, at the Federal level, copying what the UK has done in regulation terms. Improvements on these could be made, but this would be a good first step.

Good to see at least something happening, though. It is a fascinating area of banking. In the mean time, read the Austrade document. It is pretty good.

I have been asked several times for a summary of what I think about the changes to the US banking system mooted by the Obama administration. Apart from not actually addressing the root cause of the collapse I believe the suggested changes will just make the whole thing more likely to recur next time the economy downturns.

The root cause, by the way, was over-lending by small commercial banks for mortgage purposes, aided and abetted by Fannie Mae, Freddie Mac, US regulations and bigger US banks that did not look too closely at some of their risk models in pursuit of short-term profits.

The best summary I have heard, though, and one that is close enough to my own views, is this one from the BBC, which I heard driving home yesterday. Give it a listen and then think about it.

Following a suggestion I have been reading a book by Naomi Lamoreaux on the development of banking in New England1. It is called Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England.

She makes a number of excellent points in the book, and, to me, anyone with an interest in the development of modern banking should give it a look. Quite a few of the points she makes relate to the way that the improving understanding of credit risk, and the development of modern risk management, was, to a large extent, responsible for the development of modern, large banks.

I would argue, consistent with my earlier post on regulation, that it was not solely this, as an increase in regulation did play a major part, but I think it was more of a virtuous (or perhaps vicious) circle – with an increase in the size of banks, and an increasing ability to lend to whoever happened to turn up to the bank driving further regulation – which then effectively forced the smaller banks to grow or perish – creating more regulation.

The central point of the book is simple – early banking in the US (and, she presumes, elsewhere) was severely hampered by an inability to assess credit risk, so what happened was when a bank was founded it generally had several directors, men (and they were all men) of substance who effectively both lent their names to the bank and risked a large part of their fortunes in the venture.

In return, what they got was access to the banks funds, with a typical bank lending between 20 and 50% of its funds either to the directors or family members of the directors – the “insiders” of the title. They were, to an extent, protected from unlimited liability by the bank’s charter, but  this protection was often more illusory than real as to default would normally not only spell the end of the bank, but also the reputation of the individual directors.

The result was that the directors typically had an overwhelming say in the allocation of the bank’s lending, and they often lent to themselves or to others they knew well.

While today this may be looked on askance (and as possible criminal activity) then it was considered normal business for the reasons set out above. The difficulty of assessing credit risk meant that only lending to people you knew well (and, presumably trusted) was reasonably safe and, as you effectively had your own money on the line, you wanted to be really safe.

This had several effects – most people were effectively locked out of the banking system until they reached a point where they were rich enough to either own their own bank or to know someone who did. The second was that banks tended to be small – really small – with around 6 directors each and few employees. They also tended to have really high capital and liquidity ratios and charge really big margins. This then locked still more people out of the borrowing market.

The development of modern risk management practice, in all fields but particularly credit risk management, put paid to this model. While a few micro banks lingered into the modern era (and a few unit banks survive in the US) the bulk either went out of business or were bought out in the period up to the first world war.

The simple fact is that bigger banks, once you can overcome the difficulty of finding the good risks to lend to, are much, much more efficient2. If you can lend to more people, and people you do not personally know, you do not need your (comparatively expensive) directors to take every decision. You can directly obtain diversification benefits, cutting down losses per dollar lent. You can also, as a consequence, reduce your liquidity and capital ratios so you can drive more lending off the same amount of deposits (not, of course, that you can lend more than you have in deposits) and you can generally make more money.

For those campaigners for “social equity” it also makes a clear point – without modern risk management the poor are effectively locked out of the banking system entirely – so if they want (or need) to borrow funds they need to go to the loan sharks to get one. Personally, I would prefer to pay 6 to 10 percent to a bank than 20 to 50 percent to a loan shark. The bank also tend to not threaten to break my legs for non-payment. Banks can be funny that way.

The directors also become much more removed from the day-to-day operations,becoming more like the modern directors of a bank, able to reduce the risk to their own personal assets that may result from a bank collapse.

I would encourage readers to have a look for this book and give it a read, as it fills in a hole often left in the discussions on the development of modern banking.

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1. For those not familiar with the term, or who may be thinking of another New England as there are several, she means the US states to the north east of New York.

2. They can also, as I pointed out earlier, deal with the regulation better, and they can lobby government more effectively – i.e. be more efficient rent seekers.

Following on from the recent discussion regarding bank logos, this post (from this week’s cavalcade) made me think that perhaps we could do something with Australian bank names.

In the spirit of French Connection UK, then, suggestions are requested for bank names relevant to Australia (or New Zealand) that would have as big an impact as the name FCUK did.

The best entry will be close to an existing name, have real impact and would be legal to put on the outside of a bank branch.

Warning, though – anything outright obscene will be summarily deleted.

WestpacThese votes have now closed and, using a highly unscientific method, I can proclaim that Westpac has the best bank logo in Australia and that the ANZ has the worst.

ANZThe vote in favour of Westpac was very tight, but the ANZ was a clear loser.

I should add that I remember when Westpac’s new logo came out it was widely derided – along with the adoption of that name in place of “The Bank of New South Wales” – so there may be hope for the ANZ yet. Perhaps it will take just a new round of even sillier logos for the majors for the ANZ’s choice to not look that bad.

Perhaps I should add a special mention in the international category for this one – commenters variously had it as being a brassiere, a representation of tenpin bowling or, bizarrely, two reptilians talking to each other. Personally I think it looks more like two thumbs up or, perhaps what was originally intended, two people talking to each other.
Anyway, congratulations Westpac and commiserations to the ANZ. Perhaps you can get a little of the money back from the image consultants that you no doubt paid a lot.

OK – here is the (slightly) nastier one – the one for the worst logo.

While I do not particularly like the new ANZ one, I am not sure it is the worst, so have a go and see if you think there are worse one, or ones.

Voting in both these polls will end at the end of this week, so go for it.

Just to remind you – here are the (current) contenders in this poll.

There seems to have been a bit of interest in the post on the ANZ’s new logo – so perhaps we can do two votes of the back of that.

For this first one we should see if we can find the best Australian bank logo – choose from one of those below, or suggest another one. If you want to suggest another one, put it in and I will try to get a copy of it.

Just to remind you – here are the (current) contenders in this poll.

Of course – tomorrow’s vote will be for the worst.

ANZI do not often point out an individual bank’s marketing – but what is with that new logo from the ANZ? The first time I saw it I thought it had to be a joke – and then I thought about the history of some Australian bank logos and I thought it may not be. Then I saw their new ads and I knew it was not.

I am not really sure what it is – but I can think of a few things, not all of them would be suitable for publication.

If you have any suggestions feel free to add them in comments.

I have heard through the grapevine (thanks Ian at The Sheet) that Bendigo has fired the starting gun to the next big consultant’s feeding frenzy – they are talking about going for Basel II advanced accreditation.

I will be going through their numbers over the next day or so to see what this would do for them and will get back to you.

In the mean time, if you are with a major consultancy and have Basel II exposure you may want to dust of those proposal documents you did for the bigger banks, update them with the latest blurb and achievements and get them over to David Hughes (CFO) at Bendigo.

I have been away from the purely banking risk area for a little while, so I had dropped my regular visits to the BIS website. Having headed over there for some stats recently I noticed how much they had beefed up their coverage.

A few interesting things have also appeared.

Deposit Insurance

The CP on deposit insurance that they issued in March has been updated into a full set of recommendations – the paper is here. Regular readers would know my opinion on deposit insurance, but in general the principles in this paper are sound. A worthwhile note is on page one:

The introduction or the reform of a deposit insurance system can be more successful when a country’s banking system is healthy and its institutional environment is sound. In order to be credible, and to avoid distortions that may result in moral hazard, a deposit insurance system needs to be part of a well-constructed financial system safety net, properly designed and well implemented. A financial safety net usually includes prudential regulation and supervision, a lender of last resort and deposit insurance. The distribution of powers and responsibilities between the financial safety-net participants is a matter of public policy choice and individual country circumstances.

Advice to our PM and Treasurer – do not do this in a hurry and in a poorly thought out manner. Nuff said.

Basel II Changes

Pillar I

The latest tweaks to the main Basel framework seem to be trying to do a little stable-door shutting on securitisation – with a fair bit of language added around understanding the risks and a few risk weights being increased.

Pillar II

The language of the amendments to Pillar II is also interesting – this places a large amount of emphasis on improved risk management at the banks, including reporting structures, concentration management and, in particular, the off-balance sheet stuff.

One recommendation in particular is interesting – the separation of the CRO’s office out of the business lines to report directly to the CEO and Board (pillar II amendments – 19).

Securitisation

This one is also good (pillar II, para 40):

A bank should conduct analyses of the underlying risks when investing in the structured products and must not solely rely on the external credit ratings assigned to securitisation exposures by the CRAs [credit ratings agencies]. A bank should be aware that external ratings are a useful starting point for credit analysis, but are no substitute for full and proper understanding of the underlying risk, especially where ratings for certain asset classes have a short history or have been shown to be volatile. Moreover, a bank also should conduct credit analysis of the securitisation exposure at acquisition and on an ongoing basis. It should also have in place the necessary quantitative tools, valuation models and stress tests of sufficient sophistication to reliably assess all relevant risks.

I would agree – but it should not take a regulator to tell a bank this. I wonder who is going to pay for all the extra analysts – or will banks just walk away from this market?
The whole document is worth a close read and I should get around to it soon. From my scan, though, I cannot see it having a significant impact in Australia. APRA was already doing most of this – but the changes to securitisation may cause some heartache amongst those institutions that rely on them, such as many credit unions and other smaller ADIs. I would be looking to the specialist mortgage providers and the bigger banks to benefit from these.

Liquidity

As expected, as well, the BCBS has boosted its look at liquidity – with almost as many mentions in the 41 pages of this as in the 400 of the Accord itself. Given much of the problems (like those at Northern Rock) at least started as liquidity issues this is not surprising. The language looks mostly drawn from the relevant Sound Practices document, but this incorporates it into the Accord itself. Again – not much to see here, as much of this is already in the relevant Australian liquidity regulation, and APRA is well across this.

Stress Testing

Brand new is a whole two pages on stress testing. As I highlighted nearly three years ago in one of the perennial favourite blog posts here – the original accord had little to say on the subject beyond telling you that it had to be done. The two pages here go some of the way to addressing that gap, but not nearly all the way. They are obviously leaving the wording fairly general here and leaving it up to national regulators still.

Pillar III

Much of this is focussed (as can be expected) on improving disclosure around the areas that have caused problems recently. Almost all of the changes to Pillar III are about increasing disclosure of securitisation exposures – with some consequential changes to the CRM stuff. None of this should cause any banks to sweat too much – these sorts of numbers have been demanded of the banks by the regulators for a while. It is just publishing the disclosures rather than sending them to the regulators.

Wrap Up

All of these comments, though, are fairly preliminary. I will need to go through this in a bit more detail and give it some thought. If I have missed anything, feel free to point it out in comments.

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