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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.

This is the second hosting of the Cavalcade of Risk at Ozrisk. The first concentrated on the perceptions of risk, so perhaps we should move on to its actuality in this one.

Health Insurance

The recent (very recent) legislative changes in the US health insurance area makes this quite topical – but I have to admit it is not my specialist area. To put it mildly, these changes do not seem to have attracted universal acclaim amongst the health risk community in the US. The posts on it range from the concerned to the condemnatory. The most favourable to a post that was in favour was this one from Louise – but that could hardly be seen as a strong endorsement. Coming from a country that has a reasonable (but by no means perfect) health system I have always found it difficult to understand the US system, but the Australian one is not much easier to understand – but the political arguments are a little less shrill. But only a little.

Perhaps there is another way to do this, but surely it can’t be that simple.

On areas other than the health bill, Jason Shafrin looks at the perennial problem in health insurance – cost effectiveness.

Political Risk

One of my favourite topics is the attempts by the unskilled to impose their idea of the right thing to do by legislative fiat. This one, from Arizona, is a good example of an attempt to increase compliance with speeding laws – which just ends up making a mockery of the idea of compliance.

The big element of political risk is that you just do not know what the politicians are going to do next, but you can hazard a guess it will be big. Attempts to re-shape the mortgage market looks like the next big issue, and Calculated Risk has been looking at changes to Fannie and Freddie.

Nancy Germond also has a look at the hazards arising from changes in the law – and how to insure against it. Personally, I prefer mitigation, but when you can be dragged through the courts over what seem to be small things, perhaps mitigation is no longer enough. Doing the right thing can be impossible to demonstrate at times.

Lists

There were a couple of intriguing lists submitted this week as week. I am not entirely sure they are risk related, but they are worth a look for the list compulsives amongst us.

Insurance

Millie Kay G presents Get The Right Coverage! Insurance Policies You Need and Those To Avoid. Her advice seems good – particularly on pet insurance. That said, several people I know have spent thousands on operations for their pampered pooch, so maybe you should take another look at this.

Consumer Boomer looks at the possibilities of cheap Term Life Life Insurance. Perhaps sometime you do get what you pay for.

Perhaps if you do not like a contract you have just signed, you can get it declared unfair – and ignore it. Australian law can do that at times – but I am sure it is not just here.

Banking

Chris over at the Financial Services Club blog has a number of historical quotes to look at – from FDR to the IMF. It can pay to remember that there very little that is new in rhetoric about banking. If you like your analysis a little less “worksafe”, try this one on systemic risk. Always amusing, just be prepared for your internet filter to kick in.

The operational risk of dealing with the interface between a bank’s systems and its customers (i.e. the tellers or lending officers) is discussed at The Bank Channel. This can be the biggest source of operational risk of all.

It is always interesting doing a blog round up – while not as long as some, I hope you have enjoyed this one. Thanks to Henry and the Blog Carnival!

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.

There is a heck of a lot in this, so I have split this into two posts – one on the exposure draft (ED) on amortised cost (AC) and impairment and one on the (now released) “final” standard on classification and measurement – which is also long and will take a day or so. If you want to know why that is in scare quotes, go there when it appears.

As you can tell from the title, this is the one on amortised cost and impairment.

To read what the IASB has to say on this, go here for the press release and here for the content. As previously advised, I would suggest sticking to the basis for conclusions (BCs) as they are more readable, but if you want to submit a comment, you will need the exposure draft.

Having now read this a couple of times and listened to the webcast, I am still uncertain in a number of areas. I think this is going to take some work over the next couple of weeks to get sorted out and then the (now) three years’ implementation period to get roughly right.

That’s right – three years. As part of the release of this section the Board said that the earliest date for mandatory adoption will be 1 January 2013 – with early adoption permitted. This is apparently as they realise the complexity of this (I feel like saying no and a certain four letter word at this point) and to align with the prospective new insurance contracts standard. It may even be delayed past 2013 if that standard is delayed. In the webcast to night they were at pains to say they did not want to have insurance companies unduly inconvenienced by having a double change of standards.

I will work through the ED in the order in the BCs  as I have advised reading those. Where there is something in the ED that I find interesting I will cover it even if it is not mentioned in the BCs. Read the rest of this entry »

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.

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