Daily Archives: October 26, 2010

New research suggests – perhaps unintentionally – that leverage ratios are a poor indicator of impending severe bank stress or failure, casting doubt on the heavy reliance placed upon them in stress tests and efforts to make the banking system safe.

As part of a broader study, a BIS working group looked at data on 117 banks, and tried to find levels of key leverage ratios that could be used to separate the ultimate fortunes of the bank. For example, did banks with a Tier One ratio below 4 per cent always fail? Did banks with Tier One ratios above 10 per cent always succeed?

The short answer is that these levels were not very instructive. One level the paper suggests is 4 per cent for the Tier One ratio. But the actual finding is that in 50 per cent of cases, banks with more than 4 per cent did not go on to suffer severe stress, and banks with less than 4 per cent, did. Fifty per cent is rather low, however: could one similarly ‘identify’ the fate of banks by tossing a coin?

The paper says that there is no “correct” method to identifying these levels, though it seems that this should have called for a classic regression analysis. Read more

We have already identified the new rules and tools required for financial stability and should move on to prioritising our options. This was the implicit message in a speech given last night by Mervyn King, as he said we would need several options working together, and proposed a criterion by which to rank them:

The guiding principle of any change should be to ensure that the costs of maturity transformation – the costs of periodic financial crises – fall on those who enjoy the benefits of maturity transformation – the reduced cost of financial intermediation. All proposals should be evaluated by this simple criterion.

There are no silver bullets, says Mr King. Key suggestions – such as a permanent bank levy or limits on leverage – each add something, but are insufficient alone to prevent another crisis. Additional capital requirements, special resolution regimes and contingent capital also get a mention, underscoring the variety and breadth of proposed solutions.

More radical solutions – such as ‘limited purpose’ banking or functional separation – receive a more cautious treatment Read more

UK output rose by 0.8 per cent in the third quarter, according to a preliminary estimate from the Office for National Statistics. The rise is smaller than the surprise 1.2 per cent increase in the second quarter, but substantially above expectations of 0.4 per cent, and the ONS argues that underlying growth in the two quarters is essentially unchanged: “Allowing for the recovery in Q2 following the bad weather at the start of the year, the underlying growth in Q3 is broadly similar to that in Q2.” The UK’s output, or gross domestic product, rose 2.8 per cent between Q309 and Q310.

Output is likely to be restricted in the coming quarters as the spending cuts start to bite, but one of the benefits of the austerity programme has been underlined as S&P raised the UK’s outlook to stable from negative. They said: “In our opinion, the decisions reached by the United Kingdom coalition government in its 2010 Spending Review reduce risks to the government’s implementation of its June 2010 fiscal consolidation program. Moreover, the coalition parties have shown a high degree of cohesion in putting the U.K.’s public finances onto what we view to be a more sustainable footing.”

The Riksbank has raised Sweden’s repo rate 25bp to 1 per cent, citing a rapidly growing economy. Inflationary pressures remain low but are expected to rise. The country’s central bank has said, however, that the repo rate will not “need to be raised so much in the coming years.”

For a statement announcing this expected rate rise, it was pretty bearish: Read more