The Common Equity Problem in Bank Regulation · CET G-SIB Surcharge (U.S. version) 1-4.5%. Who...
Transcript of The Common Equity Problem in Bank Regulation · CET G-SIB Surcharge (U.S. version) 1-4.5%. Who...
TheCommonEquityProbleminBankRegulation
YeshaYadav,Vanderbilt LawSchoolIGIDREMFConference2017
Motivation• Bankingregulationhasbeensubjecttoenormoustransformationsincethe2008-FinancialCrisis.
• Nowwellknown,bankssufferedcatastrophiclossesin2008-2010andregulatorsaroundtheworldrespondedwithaslewofmeasures.
• ThroughtheBaselCommitteeonBankingRegulationandBaselIII,regulatorshavesoughtto(i)increasecapitalbufferswithmuchmoreequity;(ii)ensuregreaterliquidreserves;and(iii)eliminatetoo-big-to-failthroughorderlyliquidationprocedures.
• TheDodd-FrankActimplementsthisconsensusbyrampinguprequiredcapitalbuffersandliquidityreserves,mandatingstresstestsandintroducingTitleII’sOLA.
Source, Economist, World’s BiggestBankLosses, June 252009
U.S.BanksandWrite-Downs• Anumberofbankssawmassivewrite-downsduringtheCrisisandsharpfallsinthevalueoftheirequity:
Source:Bloomberg
Bank Credit Losses &Write-Downs(Billions) (Jun2007-March 2010)
EquityReturn(June2007-Dec2008)
Citigroup 130.4 -82.46%
Wachovia 101.9 -88.34%
BankofAmerica 97.6 -67.79%
JP Morgan 69.0 -31.51%
Merrill Lynch 55.9 -85.16%
Wells Fargo 47.4 -10.77%
U.S.BankCapitalBuffersPre-Crisis
• MostU.S.bankswereregardedaswell-capitalizedpriortotheCrisisandhadcapitalbuffersmuchinexcessofBasel’s8%ratioofcapitaltorisk-weightedassets.
• TheTop-20U.S.banksaveragedanaveragecapitalratioof11.6%.
• Post-Crisiscriticismsarguethatthequalityofbankcapitalwassub-optimal:didnotincludeenoughTier1Equity:purecapitaltoabsorbbanklossesandassistresolution.
• U.S.bankshadtakenonexposuresthatweretoocomplexandlargetobesustainedbytheirlevelsofcapital.
TurntoEquityPost-Crisis• Thepost-Crisisconsensushasseenamarkedturntocommonequityastheprotectivebulwarkagainstcripplinglossesandtoo-big-to-fail.
• Equityoffersbluntandreadyprotectionagainstgeneralizedrisksthatcanaffectabank.ScholarslikeAdmati andHelwig haveproposedequitybuffersofaround20%ofRWA.
Capital RequirementsBaselIII/Federal Reserve % EquityBuffer
Common Equity Tier1 4.5% (4.5%+1.5% Tier1)
CET Countercyclical Capital Buffer 0-2.5%
CETCapital Conversation Buffer Greaterthan 2.5%
CETG-SIB Surcharge (U.S.version) 1-4.5%
WhoSuppliestheEquity?
• U.S.capitalmarketshaveundergonedeepinstitutionalizationsincethe1960s-70s.
• Ratherthaninvestingindividually,U.S.homesandbusinessesinsteadinvestthroughfundsandassetmanagerslikeBlackRock,Vanguard,FidelityorStateStreet.
• Thesefirmshaveevolvedtobecomethelargestpoolsofcapital.Fundsrunbythesefirmsinvestmoneyforhomes,businessesandfinancialfirmsacrossU.S.capitalmarkets.
• Theyarealsoextremelypowerfulshareholdersincorporategovernance.
KeyAssetManagers
• BlackRockisthebiggestshareholderintheworld.Itmanagesaround$4.9trilliondollarsinassets– morethanallhedgefundsandPEfundsputtogether.
• Vanguardmanages$3.5trillioninassetsgloballyandFidelityaround$2.06trillion.
• BlackRockreportedlyhasinvestmentsinalmostalllistedcompaniesintheU.S.,andindeedhasanenormousfootprintaroundtheglobe.
• BlackRockalsorunsAladdin,anoperatingsystemthathelpsdirectaround$11trillionworthofinvestmentsbasedonitsriskanalytics.
CommonOwnership
• Antitrusteconomistshavepointedtoariseinpervasive“commonownership”inU.S.capitalmarkets.
• Commonownershipor“horizontalshareholding”(Elhauge)describesthephenomenonofasmallnumberofshareholdersoccupyingblockholderpositions indifferentcompaniesinthesameindustry.
• Fortheseeconomists,theriseofcommonownership,becomingentrenchedsincethegradualinstitutionalizationofthemarketpointstohighercosts,lesscompetitiveservice.
• Bankingissingledoutasindustrywherecommonownershipisdominant.
SurveyResults
• IlookedatthelargestpublicallytradedU.S.bankstoexaminetheirmajorprovidersofequitycapital.IexcludedbankswhoseheadofficeislocatedoutsideU.S.
• Outofthe25banksexamined,22includedbothVanguardfundsandBlackRockfundsasholdersofmorethan5%oftheircommonequity.
• VanguardandBlackRockwerealsoholdersofmorethan5%equityintheholdingcompaniesoffinancialinfrastructureproviders:ICE,NASDAQ,CMEandCBOEHoldings.
• StateStreetheldover5%equityineightbankholdingcompanies;Fidelityin7bankholdingcompanies;BerkshireHathawayandT.RowePriceinfourcompanies.
Rationale• Thismakessense.U.S.bankshavebeenhungryforequitycapitalsince2007-8.Theyhaveraisedover$400billiondollarsworthinequitycapital.
• Theselargeequitymanagersrepresentthedeepestandmostabundantpoolsofcapitalintheeconomy.
• InvestinginBHOsmightbesaidtorepresentastrategytogarnerexposuretoaswathofthebroadereconomythroughbanklendingdecisions.
• Inthelastquarters,bankrevenuehasperformedwell,withlargeprofitsreported.Though,byandlarge,bankinghasbeenvolatileandunprofitablesince2010.
Risks– ExAnte• Thedominanceofcommonownersasbigblockholdersinthevastmajorityoflarge,systemicallyimportantbanksposesrisks:
Ø Ontheonehand,theymayhaveinformationadvantagesbydintofcommonownershipacrossbanking.However,bankinformationisnotoriouslyopaque.Short-termcreditorsaregenerallyinformation-insensitive.
ØErrorsininterpretingthisinformationmaybecompoundedacrossthebankingindustry.Willshareholdersfactorinthemacroprudential componentintounderstandingrisks?
ØFundmanagersarewellknownforbeingpassiveinvestors– andactivisminbankingisdifficultandexpensive.
ØWillthiscreateincentivestogiveawideberthtomanagers?Isthereadangerthat,thelowerthevalueofthebankfranchise,themorepervasivetheincentivetorisksatcreditorexpense(e.g.correlationseeking,RichardSquire)(Dividends,Acharya).
ØCo-ordinatedactionpossible?
RisksEx-Post
• ThegoaloftheDFAandpost-CrisisrulemakinghasbeentogetridoftheTBTFproblem.
• However,thepervasiveappearanceoflargeblockholderscreatesdeeplinksbetweentherealeconomy.
• Thelossofequitycapitalintheeventofabankcollapseislikelytomakeadentinthevalueoffundsrepresentingaccumulatedretailandcorporatesavings.TheexerciseoftheOLAwillsimilarlyeliminateequityvalueintheeventabankfails.
• Thelossesmaybeespeciallymassiveispanicscreatemacro-prudentiallywideimpact,extendingtomarketinfrastructure.
• Arebailoutsinevitableifequityislikelytobeespeciallyhard-hit?
Solutions
SomeIdeas
• Corporategovernancedutiesforshareholders(see,DavidMin’sawesomepaper!)
• AgreaterfocusbyFSOCortheFedtopushshareholderstobemoreeffectiveguardiansofthecapitaltheysupply.
• Shouldlargeblockholderssetasidesomecapitalthemselvestobolsterthevalueoftheirfundsintheeventofabankingcollapse.Thiswouldreducereturnsyetfurther.
• CreateaprioritymechanismwithinCET1equitypool,potentiallyimposing lossesoninvestorsplacingtheirowncapitalatrisk,versusassetmanagersinvestinghouseholdcapital.Isthisworkable?Violatesequaltreatment?