Investors now have more information than ever before on what is inside a bank.
The third pillar of Basel, that of “market discipline”, clearly failed before the crisis – banks would present lengthy Pillar 3 reports, file 10-K forms with the Securities and Exchange Commission, and prepare a bumper annual report to boot. But it didn’t stop investors offering plentiful leverage to dangerous institutions.
Since the crisis, bank investors have had much more data, and much more useful data. They now have stress test data from several jurisdictions, portfolio level information on several asset classes, capital ratios restated for several different regimes, and new liquidity metrics. For the first time, investors can get a real sense of bank risk intensity and bank modelling strategies.
What’s more, in many cases, this is standardised information, accurate and comparable across national geographies. Since the European Central Bank published its Asset Quality Review data last autumn, investors have had an exhaustively detailed picture of the loan portfolios of more than 100 European banks, in machine-readable format.
There’s still plenty that investors don’t know about the banks they fund, and there probably always will be – commercial and privacy concerns will always hamper total disclosure, and information will never make bank investing risk-free.
But increasingly, the uncertainty about investing in banks comes from regulators.
First up, Pillar 2 capital – the “add-on” capital which a regulator can choose to impose on its charges, supplementing the hard, internationally agreed Pillar 1 requirements.
The ECB, since it took over as Single Supervisor for Europe’s largest banks, has handed out fresh Pillar 2 capital demands to all of them (as far as anyone knows). But it has not told the market what the new standards are.
Bank treasurers and capital management teams know, but the investors to whom they must sell securities do not. This is one of the most basic concerns for any investor at any point in the capital stack – how much supply will there be, or between how many others must the bank’s cashflows be split?
The UK’s Prudential Regulatory Authority, by contrast, is much more public – it discloses its Pillar 2 methodology in full, consulted on it with the market, and gives informed investors plenty to work with. This suggests the sky will not fall when investors know this information.
Other items of regulatory obscurity are making things harder still. There are clear legal reasons why current investigations cannot be discussed or disclosed in results – but when banks pay multi-billion fines geared to how embarrassing their instant messages are, rather than their presence in a market or the proceeds of wrongdoing, investors get worried.
The widespread perception that the fines are revenue-raising as well as punishments makes it hard even to come up with minimum and maximum figures – effectively rendering any detailed asset or credit work irrelevant.
On top of that is the long gestation period of regulatory change. Panellists at the Global Borrowers Forum in London said that banks were 90% through the process of regulatory change – but with blockbuster changes like TLAC, the standardisation of credit risk and the fundamental review of the trading book still to come, the final 10% looks to be the toughest.
Again, investors cannot even get close to an informed investment decision while these issues remain outstanding. Germany’s draft law allowing statutory bail-in of senior debt is widely seen as a neat and elegant solution to the TLAC and MREL problem for the country’s banks, but nobody knows which other countries will follow suit.
If a country does, it means virtually no new TLAC issuance and no new structures, and if it does not, it could mean restructured corporate groups, Tier 3 or billions of new Tier 2. It’s a binary outcome, impossible to model and price, and outside the ken of a bank investor well versed in bank credit assessments.
It’s tough to offer true transparency while laws and rules are in development, but worth making the attempt. Banks used to be black boxes; now it is their regulators.