Financial Crisis Presentation Warsaw, Poland 17 November 2009 Adrian Blundell-Wignall Deputy Director, Financial & Enterprise Affairs
Nov-2009
Fig 1: The Crisis • Too much risk taking & LEVERAGE associated with: excess liquidity conditions; poor regulations; competition & governance frameworks that encouraged the ‘equity culture’ to take over from the ‘credit culture’ in banking. Structured product & derivative growth drivers—often motivated by tax considerations. • The damage was caused by losses driving down toxic security prices (negative equity) and freezing-up markets for them: --CONTAGION risk within banks. --COUNTERPARTY RISK between banks. • Smaller banks not regionally diversified concentrating too much mortgages to fill the demand for product by securities firms also failed. Nov-2009
Fig. 2: Notional & Delta Adj. Index Tranche Obligations, Structured Credit Notes 3000
$bn
2500
Index Tranche Vols, Delta adj.($14.2trl. Cum.)
2000
Notional
1500 1000
500 0 Mar-07
Nov-2009
Mar-08
Source: Datastrean, OECD
Mar-09
Fig. 3: Notional & Delta Adj. Index Tranche Obligations, Structured Credit Notes: Main Issuers since 2007 4500 4000
$bn
Cum. Issuance Index Tranches by Bank
3500 3000 2500
2000 1500
1000 500 0
Nov-2009
Source: Datastrean, OECD
Fig 4: Forbearance & Time • Compliance with regulatory standards and accounting rules are eased. • The economy is supported with fiscal & monetary policy, and special measures. • The aim is to make the environment as favourable as possible for the underlying earnings of banks & their ability to issue new equity in rising markets. • Over time retained earnings & issuance restore capital as write-offs continue. • [The alternative is the nationalisation, deal with toxic assets & re-capitalise route] Nov-2009
Fig. 5: Two Routes to Deleveraging EQUITY % A 11% B
6% The Saving Route To Deleveraging
Nov-2009
GDP %
The Inflation Route To Deleveraging
Source: OECD
Fig. 6: Losses, Capital Rebuilding 2009 237.9
1400
USD billion
1200
Global 118.2
264.4
1000
157.6
800 600
1600 Government sponsored entities (U.S.) Insurers
1099.1
400
1025.2
200
1400
800 600 400
200
Government sponsored entities (U.S.)
237.9 118.2 204.8
Insurers
121.1 607.5
495.8
33.7
432.2
419.9
Writedown & loss
Capital raised
Asia
1200
Banks & brokers
1000
Source: Bloomberg
Banks & brokers
600 400 0
Capital raised
Insurers
800
200 Writedown & loss
54.8
1400
0
Nov-2009
600
1600
USD billion
USD billion
1000
Banks & brokers
800
0
Capital raised
USA
1400
1200
1000
200
0
1600
Insurers
400
Banks & brokers
Writedown & loss
Europe
1200 USD billion
1600
1.5 33.5
0 90.6
Writedown & loss
Capital raised
Fig. 7: US vs Europe Losses
LOSSES Years of Earnings $bn (from mid 2009)
COUNTRY USA Potential New Losses On & Off B/Sheet (OECD) Plus B/sheet shortfall to date ($97bn)
802 899
5
1027 2370
7
Europe Potential New Losses On B/Sheet (IMF) Plus $1343bn to catch up to US capital
Nov-2009
Source: OECD, Company reports and Bloomberg
Fig. 8: Fannie and Fredddie vs Private Label Mortgage Securitisation 60 % of Mtgs 50 40 30 20
Fed Mtg Pools % Tot Mtgs RMBS ABS Issuers
10 0
Nov-2009
Source: BIS
30% Cap. rise B-sheet Constraints
Fig. 9: US Bank Intermediation (Bank Loans + ABS), GDP & Real Consumption 25 20
15
%pa
Nominal GDP Bank Loans+ABS Real Consumption
10 5 0 -5 -10
Nov-2009
Source: Datastream, OECD
Exit Strategy Issues New Fault-lines Already Emerging • Asia versus the crisis countries. • The „broken dam‟ refilling anew with liquidity. • Asset prices bouncing strongly. Nov-2009
Fig. 10: US Monthly Trade Balance, Bilateral Comparisons $m
0
-10000
-20000 -30000
Nov-2009
Source: Datastream, OECD
Jul-09
Dec-08
May-08
Oct-07
Mar-07
Aug-06
Jan-06
Jun-05
Nov-04
Apr-04
Sep-03
Mar-00
Aug-99
Jan-99
-80000
Feb-03
-70000
OPEC EEC Jap Asia NAFTA
Dec-01
-60000
May-01
-50000
Oct-00
TB with TB with TB with TB with TB with US TB
Jul-02
-40000
Fig. 11: China: IP, FAI, Real M2 Exports % yoy 30.00
% yoy 100
Exports(RHS) Indust Prod.(3ma) Real M2 Fixed Asset Inv.(RHS)
80 26.00 60 22.00 40 18.00 20
14.00
0
10.00 6.00
-20
2.00
-40
Jan/99 May/00 Sep/01
Nov-2009
Jan/03 May/04 Sep/05
Source: Datastream, OECD
Jan/07 May/08 Sep/09
Jan/11
Fig. 12: Stock Markets: Better EM Fundamentals? INDEX 5.8
Japan 4.8
EU USA China
3.8
Korea Aust 2.8
1.8
0.8 Mar/03
Nov-2009
Jun/04
Sep/05
Jan/07
Source: Datastream, OECD
Apr/08
Jul/09
Oct/10
Fig 13: G20 Coordination Issues • As asset inflation pressures build in non-crisis countries, the ability to raise rates is constrained by large countries with low crisis rates—as exchange rate pressure rises. A coordination issue for the G20. • Capital levels are different in the US, Europe & elsewhere. Can all countries agree on new rules by end2010 and implement them by end-2012? • Removal of guarantees & deposit insurance—will this lead to fund shifts between weak & strong institutions & between countries? • Are we able to agree on the future shape of the financial system? Nov-2009
Exit Strategy Issues Defining What the Future Global Financial System Should Look Like. Nov-2009
Fig 14: G20 What IS & IS Not Being Addressed • Is addressed: ●capital rules—the FSB & G20 are on the right track. ●compensation—but it is a symptom only . ●accounting, clearing, back office. • Is NOT yet addressed: ●“Too big to fail” & the implicit „puts‟ & the „equity culture‟. ●Contagion risk & corporate structure—what banks should do. ●Corporate governance reform to align shareholder & management interest more generally than compensation. ●The structure of competition in banking conducive to a geographic & product regulation. ●The structure & governance of regulatory agencies to avoid overlap & conflicts. ●Tax reform to remove incentives to structuring. Nov-2009
Fig. 15: Comparative Bank Structures 80.0
%
B of Am
70.0
60.0
Citi
50.0
Barclays
40.0
UBS
30.0
Deutsche
20.0
Westpac
10.0
Santander
0.0
Nov-2009
Source: Datastream, OECD
Fig. 16: $70.6bn Payments to AIG Counterparties ($45.7bn to EU!): Sept. 16 to 31 December 2008
Institution
(billions of US dollars) Collateral postings Payments to securities for credit default swaps* lending counterpaties**
Goldman Sachs 8.1 4.8 Societe Generale 11.0 0.9 Deutsche Bank 5.4 6.4 Barclays 1.5 7.0 Merrill Lynch 4.9 1.9 Bank of America 0.7 4.5 UBS 3.3 1.7 BNP Paribas … 4.9 HSBC 0.2 3.3 [memo: Bank of America after its merger with Merrill Lynch]
Total
As a share of capital*** at end-2008
12.9 11.9 11.9 8.5 6.8 5.2 5.0 4.9 3.5 12.0
29.1% 28.9% 37.4% 20.0% 77.4% 9.1% 25.2% 8.3% 5.3% [18.1%]
*Direct payments from AIG through end-2008 plus payments by Maiden Lane III, a financing entity established by AIG and the New York Federal Reserve Bank to purchase underlying securities. **September 18-December 12, 2008. ***Common equity net of goodwill; net of all intangible assets for Merrill Lynch and HSBC.
Nov-2009
Source: Fed, US Treasury
Fig 17: Credit Culture
• Prime focus on commercial banking—taking deposits or borrowing long-term to lend to households & firms that produce real things. There is a more transparent revenue stream, transparent balance sheets more easily understood by markets & regulators. • Less exposure to securities that are difficult to price & subject to sharp volatility & liquidity shifts, that cause losses & contaminate other bank activities. • Absence of large derivative portfolios that generate huge counterparty risks. Nov-2009
Fig. 18: Concentration & Ratings
Nov-2009
Country Top 4 Banks (by Assets) Australia National Australia Bank Commonwealth Bank of Australia Australia and New Zealand Banking Westpac Banking Corporation Total Top 4 USA (bank only) JP Morgan Chase Bank of America Citi Wells Fargo (incl. Wachovia) Total Top 4 UK Royal Bank of Scotland Plc (The) Barclays Bank Plc HSBC Bank plc Goldman Sachs International Total Top 4 Germany Deutsche Bank AG Commerzbank AG Bayerische Hypo-und Vereinsbank AG Landesbank Baden-Wuerttemberg Total Top 4 France BNP Paribas Crédit Agricole Group-Crédit Agricole BPCE Société Générale Total Top 4
Top 50 rank Assets Asset Mkt Share Credit Rating A$bn % 24.6% AA 657 18.2% AA 488 17.6% AA 471 16.4% AA 440 2055 76.8% $bn 15% A+ 1,664 13% no 1,451 11% no 1,165 10% AA 1,100 5,380 49% GBP bn. 2402 18% no 2053 15% no 1734 13% AA896 7% no 7084 52% Euro bn. 2202 28% A+ 625 8% no 459 6% no 448 6% AA+ 47% Euro bn. 2076 29% AA 1784 25% AA1144 16% no 1130 12% AA6133 81%
Source: Datastrean, OECD
Fig 19: Competition & Concentration Issues • Capital and reserve ratio rules not correlated with crises. • Bank concentration is negatively correlated with crises, even after macro & competition factors are controlled for. • Low barriers to entry & less restrictions also make for efficiency & hence stability. So the role of large banks in stable oligopolies in promoting stability may be related to: ●Better geographic & product diversification. ●Easier to supervise—fewer banks with simpler business models in commercial banking. Nov-2009
Fig. 20: Non-operating Holding Company NOHC
Commercial Bank, external funding, trading etc
Invest. Banking, position taking, securities business
NOHC, Nonoperating parent. External funding, eg equity capital.
Insurance, general, life, reinsurane
Nov-2009
Source: OECD
Broker/Dlr. equity sales,IPO's, etc
Wealth mananage ment, private clients, etc
Fig 21: The Tax Issue • The tax system encourages securitisation. • Tax haven opaqueness allows capital gains and income to be shifted in CDO creation • Inequality of tax treatment of income and capital gains/losses causes CDS boom in synthetic CDO’s. • Debt versus equity bias pushes up leverage—double dipping deductions. Nov-2009
Fig 22: Corporate Governance • Independent directors: strengthen fit and proper person test to cover competence, technical expertise. Risk management skills; formal separation of CEO and Chair; term limit on board membership. • Risk officer role with access to the board (with special employment terms--CEO doesn’t fire or set salary). • Fiduciary responsibility of directors: clarified tying duties to single affiliate in the case of complex firms. • Remuneration: board reform helps, and tax incentives provide teeth. Nov-2009
