Understanding markets and power leads to one conclusion
Those who are familiar with his thinking report that he will be keen to emphasise that responsibility for managing risks lies with the firms themselves. So he will be big on reforming governance of financial institutions. He will insist that bank boards live up to their duty to set the risk appetite of firms and monitor compliance – he is good at trotting out all that Motherhood and Apple Pie stuff.
More interestingly, he is likely to press for rapid adoption by big banks in the UK and internationally of three initiatives he has been working on at the FSB:
1. The report of the Enhanced Risk Task Force to improve comparability and readability of risk disclosures, and plug gaps in current information (The EDTF is a private sector initiative mandated by the FSB which reported last month).
2. Banks to reduce reliance on credit rating agencies
3. A focus on better supervision, not just better regulation, of finance including shadow banking.
On the first, Carney probably views the level of disclosures at present as inadequate – bank accounts have been called a “black box” as far as investors are concerned. Bank directors are required to understand at least their own bank’s accounts, otherwise they’d be disqualified from serving on the bank’s board (Memo to David Walker – “please quizz Barclays directors!”) , but counterparties and investors admit they are in the dark. This causes massive uncertainty about the quality of a bank’s assets, causes banks to be valued at below break-up value and adds to funding pressures. Thus the report sets out key principles relating to
- a bank’s business models, the key risks that arise from them and how those risks are measured;
- a bank’s liquidity position, its sources of funding and the extent to which its assets are not available for potential funding needs;
- the calculation of a bank’s risk-weighted assets (RWAs) and the drivers of changes in both RWAs and the bank’s regulatory capital;
- the relationship between a bank’s market risk measures and its balance sheet, as well as risks that may be outside those measures; and
- the nature and extent of a bank’s loan forbearance and modification practices and how they may affect the reported level of impaired or non-performing loans.
The aim would be to tie accounting exposure with true risk exposure.
On the second, Carney will expect firms to make their own credit assessments rather than rely on the agencies.
But he can be expected to place most emphasis on the third leg – how well supervisors are doing. Here he is likely to insist on resourcing regulatory agencies properly – watch out, HM Treasury! – giving them clear space in which to make independent decisions – watch out Treasury! – and that they have clear mandates. He is like to confront the UK government with these demands with the full authority of the FSB and G20 heads of government behind him. The FSB could well name and shame governments that fail to implement its recommendations.
What the City may not like so much will be Carney’s hands-on approach to supervision. The complaints by boards about junior officials from the (soon to-be-former) FSA insisting on sitting in on Bank board meeting may get louder. So will complaints about the new Prudential Regulatory Authority and Financial Conduct Authority poaching hgh-quality bank staff – yet how else can they get the expertise they need quickly? Carney’s insistence on negotiating a generous pay package may be a pointer of things to come – the first good news Bank staff will have received for a long time!
Carney is well aware of these spillovers but this will not shake his belief that supervisors should be more involved with bank management, bank strategy, the appointments of CEOs and succession planning. The aim will be to force bank management to think deeply about their strategty and the strategic risks involved.
Here one has one big question. What Carney does not seem to have yet faced up to, intellectually, is whether supervision – however good – can ever be the answer to the risks run by investment banks. Those who favour bringing back partnership structures, with unlimited liability, do so precisely because they feel that the FSB/Carney approach is not appropriate for investment banks. It remains intolerable that the biggest investment banks have access to state guarantees and support. We just can’t have parts of a bank guaranteed and the rest of it free to do whatever it wants. (On this, see Paul Volcker’s remarkable testimony to the UK Standards Banking Commission).
One suspects Carney is a universal bank man. But he also understands markets, and power. If the message from the markets is that shareholders would do better if universal banks split into two legally distinct entities, let’s hope he will not resist that. This is what would happen if the State subsidy for universal banks was brought to an end. Without that power, the universal bank model would not be viable. Changes in the balance both of markets and of power could tilt in the same direction. Then the existing model would perforce give way to alternatives as outlined in The Money Trap.