A quality seminar
Effective capital management
Its expert speakers promised a lot and the number of early registrations demonstrated just how much interest there is for this year’s theme: effective capital management – once a quality, now a necessity. The Zanders Risk Management Seminar 2012, held in Amsterdam on 1 November, was a success.
“Effective capital management is a highly topical subject at the moment,” said Jaap Karelse as he opened the seminar. “Over the past few years, gaping holes have opened in the existing buffers. To reduce the likelihood of a subsequent crisis, the Basel and Solvency frameworks are expected to boost banks’ and insurance companies’ capital buffers. Billions are necessary to meet the new capital requirements.” Risk management is an essential prerequisite of adequate capital management, said Karelse. “It can help to understand the risks, benefits and pricing of financial products, and to determine how much capital is needed to cope with it.”
The first of the four invited speakers was Dr. Lex Hoogduin, who focused primarily on the role of Basel III and the European Central Bank (ECB). “We all know that we need to pull on the reins, but we should also realize that we might pull too hard. Regulation can sometimes have inadvertent and negative repercussions,” he said.
There are two extensive studies that have mapped out the cost and income of regulation, Dr. Hoogduin explained. The costs weren’t as high as expected and, as far as income goes, it is clear that the more buffers you have the more you can limit the effects of a crisis – which was also the whole point of regulation.
“A clearer instrument, such as straightforward leverage ratio, would lead us to better results”
He added: “The cost of a crisis is many times that of regulating against it. Now, however, we are much further into the process. The liquidity regulations are having much more influence on the policy than the capital requirements. Attracting long-term financing seems difficult: there is a great deal of ‘de-risking’, while what’s needed is providing more credit facilities. Liquidity rules are placing it all under even more pressure. I would therefore argue that we should take care not to force the rules and, where necessary, introduce some flexibility.” A second reservation Dr. Hoogduin had about current regulation is that it’s become too complex. “This often doesn’t work well in practice: a clearer instrument, such as a straightforward leverage ratio, would lead to better results. Above all, for the supervisor, complexity constitutes more of a problem than a solution.”
He also identified another danger: “Uniformity is the biggest enemy of financial stability. If everybody bases themselves on the same information and the same models, it makes the system more vulnerable. In this respect, the financial system is comparable to the ecosystem in that less diversity translates into more vulnerability.” Finally, Dr. Hoogduin said he feels that current insecurity is being fueled by an accumulation of rules. “There’s just no end to it: bank taxes, transaction taxes, bonus regulations. The uncertainty about the touchlines of the playing field and your position as a bank in that playing field have become a problem.”
As he mentioned in the previous issue of Zanders Magazine, we should avoid becoming mired in measures that were very useful in 2000. He added: “And for buffer regulation we should observe a maximum as well as a minimum time frame.” The audience was obviously ripe for an in-depth discussion. Several hands were raised, their owners keen to learn more about Hoogduin’s views on excessive debt load and the “double-the-dose” approach.
There were three other speakers, one of which was Pieter Klaassen, head of firm-wide risk appetite at the Swiss bank UBS. His presentation had the most specific topic: Risk Appetite (RA) “This explores the questions of how much risk you, as a bank, are able to take and are willing to take,” he explained. “It’s therefore all about choices relating to the level of risk to which you expose yourself.” He told about a report by the Senior Supervisors Group published in 2010. A key question in that report was about the estimated influence extreme situations can have on the earnings, capital (minimum Tier 1-ratio) and liquidity of a financial institution.
“An important element of an RA framework is that it is all-encompassing – all risks must be qualitatively and quantitatively accommodated,” explained Klaassen. “It’s also important to apply various risk benchmarks so the results can be translated to limits for individual risk types and made part of the risk culture.” Klaassen then went into detail about aspects that included the statistical and scenario-related benchmarks and showed how UBS views the relationship between risk capacity versus risk appetite.
In doing so he obviously linked it to the crisis of 2008: “Every bank has had the odd bad quarter; the important thing, however, is to avoid having consecutive bad quarters. Shortly before the seminar, UBS announced its plans for the coming years. It would appear that Risk-Weighted Assets (RWA) at UBS must be drastically reduced, particularly the legacy assets and RWA within UBS’ investment bank.
In closing, Klaassen showed the influence that Basel III regulations have on several products, whereby the influence on the OTC products was (relatively) high. UBS adapts the RA framework specifically to each division, he said. “The trick is to continuously find a balance between an all-embracing framework that does justice to all the various aspects on the one hand, and understandability and transparency on the other.”
After the interval, Koos Timmermans, vice chairman of ING Bank, spoke impressively to a very attentive audience in the Tobacco Theater. He began by outlining the political factors that play a role for a bank such as ING. “In defining the structure in which we will move forward as a bank, the European banking union is a very important consideration. Besides this, the Commissie Structuur Banken (Banking Structure Commission), which is carrying out research into the protection of savings in Dutch banks, is also influential. And thirdly, there are also the repercussions of bail-in debt. The conclusion is that you must retain more buffers and more capital.”
Timmermans went on to discuss the relevant rules, drawing conclusions for banking in general and ING in particular. “Besides new rules, there are banks’ reputations to consider. It differs for each country but in the Netherlands, for example, reputations are under substantial pressure. Finally, of course, there’s Basel III. All together, this means there’s a great deal to take into account. If you delve a little deeper you’ll see higher capital requirements, lower leverage and more conservative funding.”
“As a bank you must have a buffer for a buffer”
You now have to work harder for your money in commercial banking than you used to, added Timmermans. “In answer to the question: are we all enjoying a little success in this respect? The answer is yes, a little.” Timmermans highlighted some fi gures showing that ING’s capital buffers are growing robustly: its capital has doubled. “But as a bank you must have a buffer for a buffer. Not that I’ve come here to complain about it, mind; but we do have to decide what to do with it,” he said to a bemused audience.
Using various ratios, targets and prognoses, Timmermans concluded with a summary of the developments at ING, along with its ambitions. “ING is currently in the process of making repayments to the Dutch state and selling its insurance division. After this, there will be an internal amortization and then the liquidation of the group structure.”
Timmermans gave the audience a lot of information to chew over in a short space of time. It certainly impressed the next speaker, economist and journalist Mathijs Bouman, who quipped: “And just imagine he thinks three times as fast as he speaks!” The tone was thus immediately set by Bouman, the seminar’s final speaker, who continued his presentation on what he sees as a ‘muddling along’ situation in a light hearted but sharp vein. “I’m going to say a few things about your sector and I’ll be able to see what you feel about them by your discomfort in your seats,” he challenged. “We find ourselves in a ‘muddling along’ scenario, in which there are still no fundamental solutions for the banks, the euro crisis or the housing market, etc.”
He took the audience back to the precarious scenarios at the end of 2011 and last summer, when the euro wobbled. “Fortunately, Francois Hollande told us this fall that we are nearing the end of the crisis. This, of course, is ‘tough-guy talk’ but I’m curious as to what you think.” Bouman looked for interaction by asking the audience to choose one of two stances: “the worst is over”, or “the worst is yet to come”. Bouman, incidentally, was of the opinion that the worst of the euro crisis is behind us.
He then listed his thoughts and conclusions on three years of crisis featuring all protagonists who were instrumental in combating it: the reassuring words of Mario Draghi, the European solo run of Jens Weidmann, and the hip narrative of Olivier Blanchard. “All economists have become Keynesians,” concluded Bouman about the latter. “Of course, it’s also a really nice thought: we solve the crisis by simply spending our way out of it.” Naturally, Bouman stuck to the theme of effective capital management; but he peppered it with provocative statements.
“For some markets the function of the bank has ceased to be; the bank itself has become the risk. If a pension fund wants to finance a hospital, for example, it can be done on the market at a lower interest rate than would be the case if a bank was part of the equation.” Bouman told the anecdote of a Dutch company that was unable to borrow money in the Netherlands, but could do so from a Dutch pension fund in the US. “So perhaps we’re not doing it so perfectly after all,” he concluded. With a mix of content and humor, he sent the members of the seminar audience on their way to closing drinks feeling stimulated, despite the less than cheery economic outlook. Perhaps it will bring on a glut of pre-registrations for the next Risk Management seminar in 2013.
Their heads full of all things capital management, visitors didn’t leave the seminar empty-handed. They all received a copy of the Basel III book, co-authored by Charles Zondag and Chantal Comanne on behalf of Zanders, that had rolled off the presses that very same day.