Friday, December 17, 2010

Illiquid



You can see what regulators have been trying to do for eighteen months. And clearly, they are well intentioned doing it. Having reduced Australian banks' reliance on short-term funding by $140 billion or so, pushed up interest rates and talked down housing, and recently pushed back a credit-mad government, they have now announced a new liquidity regime in alignment with BaselIII.

From today's RBA statement:
The Reserve Bank of Australia (RBA) and the Australian Prudential Regulation Authority (APRA) have agreed on an approach that will meet the global liquidity standard. Under this approach, an authorised deposit-taking institution (ADI) will be able to establish a committed secured liquidity facility with the RBA, sufficient in size to cover any shortfall between the ADI's holdings of high-quality liquid assets and the LCR requirement. Qualifying collateral for the facility will comprise all assets eligible for repurchase transactions with the RBA under normal market operations. In return for the committed facility, the RBA will charge a market-based commitment fee.

As reader homes4aussies points out, this is basically a formalisation of the emergency facilities set up during the GFC when banks self-securitised $43 billion in assets and handed them to the RBA for cash.

So will the regulators succeed?

The fact that this blogger has to ask the question is the first problem. The quiet transformation of Australian bank regulation is simply too opaque. We, the public, are being asked to trust these measures on faith alone. This blogger has previously described this as Invisopower! and it leaves an analyst with the clear feeling that the true vulnerability of Australian banking is being hidden. We can't be sure yet, but this blogger will eat his hat if the new liquidity regime isn't kept hidden, just as its emergency predecessor was and remains.

That brings us to the second problem. This opacity is increasing the danger of regulatory capture. That's not an allegation. It's simply true. As the banks and regulators are enmeshed in a proliferation of elaborate relationships and supports, the banks have increasing points of influence.

Third and most importantly, this incremental approach, which is designed to nudge the banks this way and that to improve systemic robustness is not asking the really tough questions.

The Basel III liquidity provisions look laughable to this blogger. In the event of another Lehman, holding 30 days of liquid assets isn't going to do squat. As this blogger has described many times, the global economy is a three-ringed circus in which real commerce is surrounded by traditional capital markets which are surrounded by a halo of derivative insanity. Nothing has been done to rectify this. In fact, the third ring is currently working hard at expanding its influence into the traditionally cordoned-off markets of commodities.

In this world of near-infinite leverage, there is no such thing as a small crisis. There is only all on or all off. Letting banks integrate with this and expecting 30 days of liquidity to protect them is self-delusion on an grand scale.

Likewise in this world, a local or regional crisis is as catastrophic as a wider one. All of the best efforts of regulators will be utterly worthless if the global capital markets get the scent of trouble in China. The cost of Australia's enormous wholesale funding roll-over needs will rise and rise, not for 30 days, but until markets have shaken out the overspending that this borrowing funds.

This blogger will leave you with another description of the real problem, the one that neither regulators nor governments want to face, drawn from The Great Crash of 2008:
The trading of shadow instruments enabled banks to grow beyond the constraints of their domestic economy. The banks no longer needed to worry about a local funding base of savings. Instead, they could channel offshore savings into lending and asset price appreciation in their home market. These offshore borrowings were and remain beyond the support of the central bank and its national lender-of-last-resort system. Put another way, shadow instruments may be able to manage currency and interest rate risk, but they do nothing about the liquidity risk inherent in a change of global investor sentiment. In this sense, all banks that participate in the global trade of shadow instruments are shadow banks.

The global shadow banking system is as intricate, swift and beautiful as the chemical transmissions within a living organism. It is the circulatory system of global capitalism. It exists beyond the understanding and control of any regulator or nation. The system can inundate chosen assets, markets, even countries with capital, or starve them on a whim. It can transmit shocks around the globe in an instant. It is the lifeblood of the Great Crash elephant.

3 comments:

Anonymous said...

David, the illiquid is becoming the liquid with the RBA and APRA SECURED liquidity facility. What will be the price of this new found liquidity?
David, how can our banks be prepared to operate under Basel III’s liquidity regime? It is simply preposterous to think that our banks be required to maintain a stock of “high-quality liquid assets” that is sufficient to cover net cash outflows for a 30-day period under a stress scenario. We all know that Australia dose not suffer from stress scenarios. Thank God our regulators and bankers of last resort are here to bring sense to the madness of Basel III.

Great post and blog, got to go the cricket is back on.

Anonymous said...

David, was just thinking that essentially with this announcement by the RBA and APRA and the government banking reforms re: covered bonds.
We have ensured that out safe as houses banks will meet the Basel III liquidity requirements.
In Basel III liquidity regime with the Liquidity Coverage Ratio (LCR) that the LCR requires banks to maintain a stock of "high-quality liquid assets" that is sufficient to cover net cash outflows for a 30-day period.
What is included as a High Quality Assets?
The banks' liquidity pools have to be at least 60% Level 1 assets (cash, central bank reserves, and sovereigns) and no more than 40% Level 2 assets (GSE obligations, and non-financial corporate or covered bonds rated AA- or above)
The RBA will also be able to ensure through its lending ‘liquidity’ facility the proposed run-off rates to each above mentioned source of funding (central bank reserves and covered bonds), they will also be able to ensure the funding maturity will not roll over in the 30-day window.

Just a thought!

dingo said...

Interesting post. Agree there is way to little transparency. But probably still better in Oz than elsewhere. It is very hard to get a proper fix on situation in EU/US and work out how we compare. How many European banks, say, will be able to meet Basel III requirements? Is this even really relevant anymore?