Some time ago in the Propaganda War series (Markets don’t Fail, Risk Weighted Lies, Balance Sheet Instabilities, Toxic Bloom of Lies and The Banker’s Mexican Standoff ), I questioned the system of jargon which banks and their regulators use to assure us, and perhaps themselves as well, about the risks they run, and their claims of having it all under control. I suggested that the concepts, for all their pretensions to mathematical precision, were dangerously stupid and actually little more than self-serving piffle.
In Toxic Bloom of Lies, I looked in particular at the technical sounding notion of Risk Weighted Assets. A bank’s Risk Weighted Assets are just the amount the bank expects to make back on the loans it has given out, multiplied by some estimate of the risk that some or all of the income from the loan might not be paid back. Not that complicated really but essential if you want to really know how solid a bank is. Of course the obvious question is who gets to set the risk factor?
And the answer is, part of Europe’s Basel II banking regulations called the Internal Ratings Based System (IRB), allows the banks themselves, subject to ‘approval’ of course, to decide how risky their assets are and how much they think they might be in danger of losing on them. In Toxic Bloom of Lies I wrote and then quoted from the legislation,
They decide their own risk according to their own model… but subject to approval.
All institutions using the IRB approach will be allowed to determine the borrowers’ probabilities of default while those using the advanced IRB approach will also be permitted to rely on own estimates of loss given default and exposure at default on an exposure-by-exposure basis.
Advanced IRB as well! Of course the models being used are proprietary and therefore NOT open to scrutiny by any outside experts. What do you think, if the bank’s experts came up with two possible models one of which gave a lower over-all risk weighted total which do you think the bank would go for? And if another bank came up with a model that shaved just a little bit more off the risk weighting do you think there would be a subtle pressure to match the undoubted brilliance of their competitor’s model? I leave you to decide
When I wrote that I did so as just another disgruntled pleb. Today the FT reported,
Fears rise over banks’ capital tinkering
Concern is growing that banks in Europe and elsewhere are moving to meet new tougher capital requirements by tinkering with their internal models to make their holdings appear less risky.
The article went on to explain,
So many of them are instead trying to reach the required ratios through … what they call “risk-weighted asset optimisation”. In some cases, that means selling or running down risky assets, but in others, it means changing the way risk weights are calculated to cut the amount of capital that will be required.
The same article reports that in 2010 Lloyds bank reduced its risk weighting on various overseas assets and suddenly found it needed to hold £16 B less capital against them. Convenient. Turns out Santander is doing the same, as is Commerzbank after its merger with Dresdener Bank and even Spain’s second largest Bank BBVA finds that the present turmoil in Spain is no barrier to reducing the risk weighting of it assets as well.
All the banks have to do is create their own proprietary computer model with which to model their assets and their risk and like some bought and paid for oracle it tells the world the bank is more solvent and its assets less risky than anyone had suspected. Of course I am being terribly one sided in my description. I have not said a word about the fact that these risk models and the results they hand the banks will be overseen not only by national regulators but by the European Banking Association (EBA) as well.
As the article concludes,
Supervisors in the UK and elsewhere also said they will be looking carefully at bank plans to reach their new capital requirements and intend to come down hard to anything they see as cheating.
Of course we might reflect that it was the EBA with national regulatory authorities which only last year ran a second bank stress test on 90 of Europe’s banks about which the EBA said in its final report,
The 2011 EU wide stress test contains an unprecedented level of transparency on banks’ exposures and capital composition to allow investors, analysts and other market participants to develop an informed view on the resilience of the EU banking sector. (P.3)
‘Unprecedented transparency’. We are not worthy! But wait there’s more,
The results were scrutinised and challenged by home country supervisors before a peer review and quality assurance process was conducted by EBA staff with a team of experts from national supervisory authorities, the European Central Bank (ECB) and the European Systemic Risk Board (ESRB). (P.2)
‘Scrutinized’, ‘challenged’ and peer reviewed by ‘teams of experts’ from places mere mortals have never even heard of. Let us raise a hymn to them! ….And yet…
However, the EBA has relied on the quality review work of national authorities and on the internal processes of the banks to assess such areas as earnings trends, asset quality, model outcomes and the magnitude of the impact on assets and liabilities. (P.2)
The ‘internal processes of the banks’ were relied upon for assessing ‘such areas’ – as if these were just a few peripheral details – ‘asset quality’, ‘model outcomes’ and ‘the magnitude of impact on assets and liabilities’. In other words the banks were ‘relied upon’ for everything of substance. The banks tested themselves and the only things scrutinized by all those experts from the EBA and elsewhere was the lunch menu.
Or am I being unfair? Let me see. What did all those experts conclude? Oh I know. Not one Spanish Bank was thought to require any additional capital beyond what was already planned. They were all fine. Not just fine as they were then, but fine even under the test’s most adverse scenario. Bankia was one of those all the experts looked at and declared fit as a fiddle. Now look at it. First it was fine. It even declared a profit. Then suddenly it was bust and needed the tax payers to give it €3B. That figure doubled. Then it doubled again. Now no one is sure.
What happened to all that risk weighting? A little out were we? A few assumptions short of reality? Bankia is the ugly reality that heaves to the surface when all the expert computer modelling and pompous assurances of risk weighting are done and over. It won’t be the last. Why should anyone have faith that the EBA’s oversight of other banks, their models and their risk weighted lies was better than it was for Bankia?
There was no transparency. There was no honesty. No integrity. No honour. What we have is an aristocracy who lie and connive together to shower us with the shit of their wastrel lives.