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COMMENTARY: The wrong crisis
It is a little unsettling that, 11 years after the start of the financial crisis in July 2007, the debate about its cause is still going on. Economic historian Adam Tooze has just weighed in, publishing Crashed: how a decade of financial crises changed the world, in which he makes the point that the financial crisis was devastating in part because it was unexpected. The consensus was that the next crisis would originate in China, based on a macroeconomic perspective that observed the huge transpacific debt imbalances between China and the US, in particular. But a “macrofinancial” perspective, Tooze points out, would have shown accurately that these were dwarfed by the reliance by US and European banks on huge transatlantic flows of interbank lending – and when these started to falter disaster soon followed.
All this makes any observer wonder what we will get wrong about the next disaster. This week, Risk.net looks at the lessons of the financial crisis from three perspectives.
Efforts to reduce the risks associated with counterparty credit exposure seem to have been broadly successful – the largest banks are smaller than they were, with less assets, less risk and in particular a smaller degree of interconnection with their peers. Their growing reliance on internal model-based valuation could be a cause for concern – though in this context it’s interesting to note that many European banks are also moving away from internal models for their operational risk capital.
But risks could be growing around ring-fencing, Credit Suisse’s Wilson Ervin argues. Seen, especially in the UK and US, as the answer to the failure of a major bank, ring-fencing makes sure each subsidiary has enough capital and liquidity on hand in the same jurisdiction to handle its failure. Ervin argues that this means the banks are sacrificing the flexibility of having a “mobile reserve” of capital. Therefore, although ring-fencing could make resolution easier and more certain, it also makes it more likely to be necessary.
Supervisors also have much to learn about the traits of problem banks, writes former Bank of Spain head of supervision Aristóbulo de Juan. Fooled into risky behaviour by excess liquidity, they fall into a pattern of deception and malpractice that means the true severity of the problem may take too long to become clear – unless regulators and supervisors are prepared to be aggressive and attentive.
STAT OF THE WEEK
The capital held by the five largest UK banks against credit valuation adjustment (CVA) to their derivatives portfolios fell by £260 million ($335 million) in the six months to June 30. HSBC saw the largest percentage drop with a $300 million reduction, or 38%, as a result of CVA risk-weighted assets falling from $9.5 billion to $5.7 billion.
QUOTE OF THE WEEK
In response [to the 2008 crisis], many jurisdictions adopted stringent controls for local subsidiaries. De facto geographic ring-fencing of capital and liquidity became a common strategy to reduce the risk to national interests. Some moves happened quietly, while others – such as the US intermediate holding company rule and the European Union’s intermediate parent undertaking proposals – were public affairs… These constraints have emerged nationally, without a global framework or international debate, and well in advance of serious stress conditions. We believe they pose a serious threat to the progress of post-crisis banking reform – Wilson Ervin, Credit Suisse