Banks are opaque, or so I hear, and so the only way many people can stand to be around them is if they can have some sort of number to serve as a flashlight into all that opacity. One of the big numbers is Basel III risk-weighted assets, which are intended to, as the name says, measure how much stuff a bank holds, weighted by the riskiness of the stuff. RWAs are related to another popular number – they are in many cases calculated based on value-at-risk models – and they determine capital requirements: the more risky assets you have, the more long-term loss-absorbing funding you need to have, to insulate you from loss if the risks come true.
All numbers deceive, though, and many people have noted that RWAs vary wildly across banks, with some banks reporting much lower RWAs per total account assets than others without any obvious decrease in risk. And since RWAs are based in large part on internal models, there is some suggestion that banks optimize their models to reduce RWAs. So risk-weighted assets don’t have any obvious correlation with (1) risk or (2) assets.
Which seems bad, as a first cut, but maybe isn’t: not having an obvious correlation doesn’t mean there’s no correlation. RWA critics are just looking at public information, and public information is, as noted, opaque. Maybe all the banks really are consistently and conscientiously measuring the riskiness of their assets, and just happen to hold different assets. Which is why it’s nice that the confab of bank regulators at the Bank of International Settlements went and issued a report on consistency of risk-weighted assets for market risk.1 The authors of this report, between them, regulate pretty much every big bank in the world. So they could go look at each bank’s trading book, see what assets they have, see how they risk weight them, and compare that to how other banks weight them, done.2
One kind of immediate thing to notice is that that didn’t happen. They’re as confused as you are: Read more »
A thing you might want is for investors to be able to understand the financial situation of the companies they invest in. Traditionally, that is a thing that many people want, anyway.* Much of our system of corporate finance is dedicated to that and it mostly works okay.
A place where it breaks down a bit is in financial institutions. Because big financial institutions more or less take shareholder money, leverage it 10 or 30 times, and invest it all in a large and ever-changing mix of mark-to-market assets, some of which they mark themselves. Then they tell you things like “our assets have a current expected value of around X, with a daily variance of around Y” and since they’re sporting they also give you some sort of rough breakdown of what classes those assets fall into and stuff. This does not give you precise confidence about what those assets are worth today or what they’ll be worth in a week. And you can’t really find out much granular detail about the assets, because disclosing them all would be a competitive problem and/or just take too long / make your eyes glaze over. If you’re lucky maybe the banks disclose in some useful form actionable information about whatever you’re currently worried about, but you’re probably worried about the wrong things anyway.
So you do the best you can, and rely on external sources, like ratings agencies, who might know more than you, maybe, sometimes, or like Warren Buffett. Or you rely on government oversight to keep your financial institutions more or less solvent. But regulators, too, need some sort of heuristic for figuring out what assets are risky and how risky they are. After all, a big part of their job is regulating those risks, by doing things like setting capital requirements. It turns out that this is hard. So they sometimes outsource that job to ratings agencies. That doesn’t always work. Then they get all “we’re going to stop outsourcing risk regulation to ratings agencies.” That doesn’t always work either.
Vikram Pandit has his own idea and it’s pretty neat: Read more »
Boy, those new Fed regulations, they are long. They have lots of things. Like stress tests, and liquidity buffers, and the thing where you can’t have credit exposure of more than 10% of your regulatory capital to one bank.* But the thing that they mostly have are capital requirements, which are kind of not that surprising, i.e. they seem to be Basel-esque including G-SIFI surcharges, which is terrible if you’re Jamie Dimon, but also wonderful if you’re Jamie Dimon.**
I’ve never really understood bank capital regulation, like, deep in my bones. You can risk-weight it. You not risk-weight it. You can do other things. I don’t know.
One thing you can’t do, though everyone does, including me sometimes, is say that banks have to “hold capital.” Clive Crook in Bloomberg today says a number of interesting things but most importantly he’s today’s person pointing out (emphasis added)
a popular fallacy: the idea that equity sits idle and unused on a bank’s balance sheet as a kind of overhead. In fact, equity is just another source of funds. The proceeds from a sale of equity can be lent out or applied to other purposes just as readily as proceeds from, say, taking a deposit.
That’s, like, important! The first part, the overhead thing, whatever. The second part, that “equity” and “capital” are words you say about funding, not assets, is a thing that you should know. If you don’t know it, go find it out. Crook goes on to say: Read more »