Ooh look a chart:

That’s from this quite punchy paper by Patrick Slovik of the economics department at the OECD. It shows you that, in 1992, big banks had risk-weighted assets, which determine how much capital they’re required to have, of over 65% of their total assets, which measures how much lending and investing and trading and financing-their-governments they actually do. In 2008, the ratio was under 35%. What’s special about those dates?

When the first Basel accord was implemented in 1992, risk-weighted assets represented close to 70% of bank total assets, which means that bank regulatory capital was calculated based on a large share of bank total exposures. In the years following the introduction of the Basel accord, the ratio of riskweighted assets to total assets (RWA/TA ratio) gradually decreased and reached about 35% in the immediate pre-crisis period, which means that the regulatory capital of systemically important banks was calculated based on only a small fraction of their total exposures. … [T]he drop in the RWA/TA ratio has been very smooth since the implementation of the Basel accords without any significant deviations from the trend line until the crisis. This trend suggests that innovative engineering of regulatory risks and the move to unconventional business practices by systemically important banks has been a consistent trend for almost two decades and was not limited to a few years preceding the financial crisis. The trend reached its lowest point at the onset of the financial crisis when the capital requirements of systemically important banks were determined based on the historically lowest amounts of risk-weighted assets (relative to total assets). Risk-weighted regulation leads to unintended consequences as it encourages innovation designed to bypass the regulatory regime rather than to serve non-financial enterprises and households. Strengthening capital requirements based on risk-weighted assets may further contribute to these skewed incentives and their profitability.

This is a theory that has been sloshing around the internet for a good long while but this is neatly expressed and – that chart! It is – pretty stark, no?

That chart is worth the price of admission, but Slovik goes on to argue that risk-weighted capital requirements lead to a decline in lending activity: “One of the main reasons why non-loan-related activities have become so important for banks is the relatively high regulatory risk weights on loans relative to other types of assets, which puts them at a comparative disadvantage in the profit-seeking strategies of banks.” The numbers look … not totally unlike the risk-weighted-to-total-assets chart: Read more »

  • 14 May 2010 at 2:45 PM

Goldman To Stop Prop Trading In CLOs

“A group of traders who were focused on making bets on collateralized loan obligations with the New York-based firm’s own money are now handling trades for clients, the person said, speaking anonymously because the plans aren’t public…Goldman merged the proprietary trading desk with the team that handles transactions for clients as it wound down the positions in the proprietary trading book, the person said. Both groups were run by Gerald Ouderkirk, who was promoted to managing director in October 2006.” [Bloomberg]

  • 04 Nov 2008 at 9:45 AM

Buyout Loans: Next In Line?

For all the talk about crashing mortgage backed securities, there has been little discussion of the increasingly shaky foundation of loans for leveraged buyouts. This subject hasn’t gotten as much press as the mortgage issue, likely in part because it is a less populist story. And so, when an article on Goldman’s massive hedge fund losses crosses the wires at Bloomberg, CLO writedowns get a single line, buried in the middle of the piece.

Moszkowski also estimated that Goldman will write down its leveraged loan portfolio by $1.3 billion in the quarter because of a drop in that market.

Still water runs deep?
Goldman to Post Loss in Fourth Quarter, Merrill Says [Bloomberg]