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As discussed below, quarterly disclosure of assets, credit quality and capital is supposed to be one of the “pillars” of the modern regulatory model governing Australia’s banking industry. Yet the mandated disclosure of this data is uneven, sometimes unavailable and, by and large, poorly read.
It was not meant to be this way. Theoretically, depositors and other investors in all banks were meant to take this information into account before making investment decisions. The fact that this is not happening means one of three things – it should be dropped as it is useless, it should be fixed or it just needs more time as people catch on.
The third possibility can be ignored, as the sheer difficulty of getting the data means that it is not probable that it will be done on a regular basis.
If we look at the second, then improvements clearly need to be made. Firstly, the target market for these disclosures needs to be determined – something that probably was not done before APS 330 was issued. In short – who is going to use this data? If it is the retail depositors, the mums & dads, then the data on the reports needs to be turned into something they can read and understand.
Some of the issuers of these reports are already doing this. Seventeen of the 121 issued reports feature explanatory information that may be accessible to the (relatively) unsophisticated user. Of the Big Four this includes CBA, the NAB and Westpac, with the standout being the Commonwealth. Their risk report seems to attempt to explain the whole 333 page Accord in each disclosure statement, the most recent of which was 87 pages long and includes a mass of detail.
Most of the disclosures, though, would have been meaningless to most mums & dads. To do as the Commonwealth does would also be a virtual impossibility for the small credit unions. Even to match, say, Westpac would be difficult.
Most of the disclosures simply take the bare compliance route – APS 330 mandates the tables to be included, so the data is in tabular format will either little or nothing by way of additional information. This is pretty difficult to read at the best of times.
Worse, and as is true of most disclosures, they really only are very useful when you can compare them to a competitor or to the institution itself, something that even the most sophisticated mum or dad would find difficult and time consuming.
If the target for the data is the wholesale market and credit risk analysts, the way that it is presented is also a problem. Given most institutions do not preserve a history on their websites, to get a meaningful data history means that an analyst would need to visit the websites of most of the 119 institutions that have one at least once every three months to get a full picture. For the four that don’t have a website an email or phone request would be needed.
The data would then need to be extracted from every report and then manually input into an analysis package.
This is clearly a lot of effort and, given it has not yet happened other than for this study, seemingly not a popular idea.
A possible technical solution to this would be for every ADI with a website to publish the data in a consistent way – possibly using XML or a similar method – to format the data for easy import into an analysis package.
Of course, this would mean than the 17 that are providing more and better information would have to be “dumbed down” to re-join the pack. Either that or they continue to produce the APS 330 formatted for general consumption as well as this other method.
A third possibility is that APRA itself publishes the report every quarter using data from its existing returns from each of the reporting institutions. This would have the benefit of a standard format and ease of finding. However, if APRA were to publish these reports then it would be difficult to avoid the impression that APRA has in some way endorsed the contents.
Perhaps they should be cancelled then – but this may be a breach of the Accord itself. There are two reasons why it may not be. The Accords were always meant to apply to “internationally active” banks, not to institutions with less than $1m in total capital. For the non-internationally active banks compliance with the Accord was a policy decision by APRA, not a requirement of the Accord.
Additionally, the Pillar 3 on which APS 330 is based speaks clearly about the concept of materiality – how it is the users that matter to this concept. The fact that there are so few, if any, users of these reports from the smaller financial institutions may well mean that the information is not actually material.
It’s clear that the APS 330 process, at least as it applies to the smaller institutions, needs to be re-thought. If we want to keep this form of market disclosure then it needs to be made useful to at least one group of investors or analysts. If the statements are not being used, then, perhaps, they should be dropped.
This is not coming out of retirement. I wrote this piece for Banking Day (an excellent way to keep abreast of banking in Australia) and I thought it may also be of more widespread interest. There will be one more piece tomorrow before I go quiet again.
Quarterly disclosure of assets, credit quality and capital is supposed to be one of the “pillars” of the modern regulatory model governing Australia’s banking industry. Yet the mandated disclosure of this data is uneven, sometimes unavailable and, by and large, poorly read.
Basel II Pillar 3 is the part of the international bank capital Accords that was intended to improve the discipline that the market imposes on banking institutions. It was meant to do this through increasing the amount and nature of disclosures that the banks (and other deposit takers) make on a routine basis, using the idea that more disclosure means there is more data and therefore better pricing.
There are, of course, two problems here. If the markets themselves are not pricing risk correctly (for whatever reason) then all the disclosures possible are not going to do the trick. The other problem is around whether anyone actually reads the disclosures.
The recent experience in Europe gives real pause on the first point. The Basel Accords themselves may be at least partially at fault here. The Accords effectively tell the banks that lending to their own government is so safe that they do not have to hold any capital at all against it. Most countries’ regulators also mandate that the bonds they receive for this lending are also always able to be sold instantly, and so count as being as liquid as cash.
Both of these now look, at best, overly optimistic.
What about the second, though? Does anyone actually read the disclosures and use them? If we turn to smaller Australian banks, building societies and credit unions, the answer seems to be a strong “No”.
Over the last few months these disclosures by all of the 123 banks (including the big four), building societies and credit unions operating in Australia have been collected as part of a research project. According to APS 330 all of them should have been reporting these every quarter since September 2008, making (so far) 12 reports in total.
There are also two differing types of disclosures – for listed banks or building societies extra disclosures must be made semi-annually and for unlisted institutions the extra disclosures are made annually.
There are still several faults in the process, with a couple not reporting at all and others not reporting fully or properly.
Both of the institutions not reporting were very small, but several of the other problems were more wide-spread. Of the 121 actually publishing, eight seemed to want to hide the results, making them virtually impossible to find on their websites, while six institutions had missed important data off the disclosures, including core numbers such as assets and impairments.
Three of the disclosures had clearly not been formatted for any sort of use.
Other problems were more widespread. For the June quarter end 14% (17 in total) of the disclosures were not out on time (40 business days after the relevant quarter end) – and this included three of the 12 banks.
The widespread issue, though, is that nearly 70% of the institutions are only making their most recent disclosure statement available – meaning that there is often no history or context, but, more importantly, for most of these the annual or semi-annual long disclosure is not on their website for at least half the year.
The other major problem is the sheer difficulty in harvesting the statements. The way that APS 330 mandates the disclosures is that they shall be put up on an institution’s website in a clear location. Formatting is meant to broadly follow the formatting in APS 330 – consisting of a variety of tables.
This was set up with the idea that an individual depositor could go to their institution’s website or offices and get a copy and then read it and understand their institution, and their risks, better. The problem here is that the basic format, and target audience, has not been thought through. There are not many depositors in the smaller institutions that would know the meaning of “Risk Weighted Assets”, “Tier One Capital” and the difference between 90 days past due or specifically impaired. Judging by many of the disclosures, not many of the preparers do either.
For your normal depositors, then, the disclosures are nearly useless.
For professionals, the situation is not much better.
Four ADIs do not have websites, making getting the data from them a process of calling or emailing them to ask for the data. For the others, it’s a matter of trying to find their website either by guesswork or using a search engine. If you are trying to get them all together and put them into a database it is a very time-consuming job.
The only people who may actually be able to use them, the wholesale providers of funds to the smaller institutions, would be able to get much better and timelier data direct from management.
There seems to be at least a few people reading, and using, the disclosure statements of the Big Four and Macquarie. This includes Banking Day readers, as the APS 330s for the majors are regularly reported there. However, it has not been noticed, least of all by APRA, that some institutions are not reporting at all, others are missing important data, several are late and most are not disclosing all of the data on a consistent basis.
It’s clear that the APS 330 process, at least as it applies to the smaller institutions, needs to be re-thought. If we want to keep this form of market disclosure, then it needs to be made useful to at least one group of investors – or analysts. If they are not being used, then perhaps they should be dropped.
I have just started reading a book by Tim Carney entitled “The Big Ripoff” and he makes many of the points I have made time and again – the effects of regulation are generally not the ones you would expect.
The fans of regulation are generally taken to be opponents of “Big Business” and they call for more regulation as a counter to the (alleged) pernicious effects of having large companies. Most of these effects are easy to see – strong pricing power, reduced service and many other things that are bad for the consumer.
The argument that Carney puts forward, though, is one I have been making for some time – both on this blog and elsewhere. The argument is a simple one. The more regulation you have in a market the more that regulation will favour the big suppliers – i.e. the larger incumbents – over the smaller incumbents, any potential new players, and, crucially, the individual consumers. So the more that you regulate the worse the situation gets for everyone but “Big Businesses”.
The reasoning is simple to see if you think about it – compliance is expensive. I know this as a simple fact – and my fee base confirms it. It costs money to comply with regulation. The more complex it is the more expensive it gets. For example – complying with the (old) Basel I Accord was a simple exercise. While it took a fair amount of work to get compliance when it first came in in 1988 / 89 most banking systems could comply with it fairly quickly and, importantly, cheaply.
While Basel II is a much better (i.e. risk sensitive) set of standards there is (I think) no-one out there that would claim they are simpler than Basel I. The amount of money that even a small bank following the Standardised / Basic methods of compliance had to spend was a fair leap from the amount they had to spend to spend under Basel I, and the amounts you have to spend to comply with the Advanced methodology (and therefore to get a substantial capital advantage) was many, many times more.
There is simply no way that a small bank or a new player can afford this without the belief that they will become a big bank (and therefore Big Business) as a result.
Even to keep the people needed to continue and upgrade these systems is expensive and needs a high (and profitable) turnover. There is no other way.
All of this means one thing – that more regulation makes it relatively more expensive for small businesses to operate that for large businesses and it imposes high barriers for new entrants into a market. Regulation therefore tends to help big business, not hinder it.
BTW – I should add that a post at catallaxy reminded me to write this one.
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.
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
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.
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).
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.
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.
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.
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.
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.
Jennifer (see the previous post) pointed me to this presentation to the IAA’s annual conference by Dr. Mark Lawrence. While it breaks many of the rules I normally set for a group of slides it is one of the presentations I would like to have been at.
While I do not agree with all of it (he thinks that fair value accounting is an issue, for example), it makes a number of very good points – for example:
Regulators should support the private sector’s efforts to improve transparency, with particular reference to harmonization of disclosure requirements among different jurisdictions. The official sector should work closely with industry and market participants to improve market understanding of Pillar 3 disclosure content. Disclosure requirements should be based on a risk-and principles-based approach to qualitative as well as quantitative information
In the view of many, culture is the single most important determinant of risk management effectiveness
Risk Managers concerns [are] often pushed aside [ask HBOS about this one]…
Capital models were originally created for important business purposes, and won’t go away …
Therefore, users (and supervisors) must understand very well the weaknesses and limitations of the these models:
- exactly what is measured, and what is not
- exactly what the models can and cannot be relied upon for
- when they work (i.e., under what conditions) & when they don’t
It is worth at least a read. The point about understanding your capital models is crucial. They are not and will never be the be-all and end-all of risk management. Like any model they are only as good as the common sense put behind them.
Bank capital allocation is normally a pretty dry subject – and that is to people who work in the area. To the rest of you it must be sleep inducing. That is, until you consider the real effects that it can have.
This is a follow on piece to yesterday’s article.
On a macro level, of course, the differences in the capital charges (between Economic, Regulatory and Total) drive some really odd behaviour. The effects on an unregulated institution (or one without effective capital regulations) are that, in the absence of regulatory restrictions, they can hold assets with less of a capital charge than a bank. This means that, if the bank lends the money out in the first place, the loan is worth more to an unregulated institution than to a bank. Selling the loan then means that both parties make money on the deal. It also means that it is worth trying to get the home loan into a different regulatory capital category – say as a traded instrument rather than a loan.
Banks therefore bundle(d) these up into corporate vehicles (securitisations) and tradeable instruments (CDOs etc.). If the bank can get the loans off their books then they can make the money from the initial fees from lending, selling the loans and also from managing the loans once they are off the bank’s balance sheet.
If the loan is sold and the bank retains little or no credit risk (i.e. if the loan goes bad then the bank does not have to pay) then the incentives are simple – write as many loans as possible regardless of the credit risk provided you can then sell them. If housing prices go up then there is no problem at all – everyone (including the borrower) stands to make money. The bank gets a fee for originating the loan, the purchaser of the loan makes money off the interest and, if the loan goes bad gets the remaining funds from the sale of the house and the borrower gets to live in the house and may well be given some money at the end when it is sold.
If prices go down, though, it is another story. The originating bank still makes money, the borrower (in the US at least due to the without recourse lending) gets to live in the house until foreclosure but the loan purchaser gets stuck with any losses, as has happened in the US over the last year.
The point here is that the excess and disproportionate requirements of regulatory capital is one of the main things driving this. People will always try to make money and should be (justly) condemned for doing so when it involves fraud or negligence, but the system itself should not create the incentives in the first place.
Creating a CDO or securitisation costs money. There are legitimate reasons for them to exist (some banks are better at lending than borrowing and some investors want to be able to lend specifically for housing for example), but having them drive adverse lending behaviour can cost vast amounts more money. Reducing the incentives for them to exist means fixing the regulatory capital weights.
Until that is done merely requiring more capital in banks will increase, not reduce, the problem.
I was asked a question today that I thought would be interesting for the general readership – to see what approaches were being used. To quote the question:
My … question for you is regarding retail pooling……as you know, when we implemented in <deleted>, each exposure was individually assessed and the pooling approach was not adopted.
Given that SMEs have the ability to fluctuate between Corporate and Retail classifications, how does that work from a model perspective for banks that have adopted the pooling approach for retail? For example, a business is assessed using a non-retail application scorecard as it meets corporate criteria and a PD is calculated. If that business then ceases to meet the corporate criteria would it then need to be allocated to a Retail pool? Then what happens if it pops back into the Corporate bucket?
I can only assume that this is not dynamic managed and that there would need to be some manual reclassication / reassessment of the exposure.
I know what my response would be, but I would be interested to see what approaches are being adopted outside my own little world. Comments?
Given that these disclosures have started to settle down into a slightly more regular pattern, I will be expanding my analysis to look at more areas. In particular, I intend to look at what the actual content of the numbers is saying about the risks embedded in each of the banks. As the vast majority of the numbers relate to credit risk, this is where I am forced to concentrate.
Firstly, though, a big warning to all. All of these numbers below are based on the disclosed numbers as I have read and, in some cases, aggregated them. They are not in any way official numbers from the banks and you should go back to the source documents (as linked previously) if you want to look at them seriously. As all of the tables I have used have some variations across each of the documents I may have mis-interpreted the numbers in some way. If you spot one, or merely have a question, please put it in comments or contact me on the email address given on the “Authors” page.
There are also a few oddities in the data that make me question my own numbers. So, please, do not rely on these and I will not be interested in any claims that you made any financial decisions based on the below. It’s a blog post, for heaven’s sake.
Disclaimer over – on to the numbers.
You would have heard me by now praising CBA’s disclosures, so I will not bore you again with them. OK, I will – yay, CBA. Keep at it. It is just a pity the government guarantee means that you will not be rewarded for it, but, chin up, it will go soon (I hope).
Just a quick reminder here, though. All of the numbers and discussion below is given relative to other banks in Australia. If you compare these numbers to almost any other in the world today you will find the Aussies are far better than most. None of the Oz banks are even trading close to making a loss. Westpac, for example, had the best return on equity of any major bank anywhere last year – and the others are not far behind.
NAB and CBA
The numbers from these two, though, are a study in contrasts, While they have much the same sized portfolio overall (NAB is slightly bigger overall), CBA is more weighted towards the housing end and NAB towards business. In the good times, this served the NAB well in profitability, but it is now hurting in terms of impaired assets and arrears. NAB, despite having only about 16% bigger book (in EAD terms) has about 50% more impaired assets. It also has more loans at over 90 dpd, although CBA, because of its bigger book size, has more residential mortgages overdue. Oddly, though, this has not followed through into the impaired category. My guess here is that many of the NAB’s residential mortgages were used to back business loans, which have been more likely to get impaired quickly.
The rest of the assets story is more or less as you would expect. NAB has many more of its assets in the Standardised categories, mostly because they have substantial overseas assets that they (presumably) have not been able to get a model approved for as yet. If they do not soon do so it may make sense to dispose of them to someone that can.
Overall, 22% of their assets are held in Standardised portfolios, as opposed to 6% average for the others. more work required here, I would have thought.
None of the rest is startling, So I will put some more push into completing the analysis on the overall comparison.