Tag Archives: Bank

Blockchains in Banking (Commercial and Central)

The Economist reports about initiatives by commercial and central banks that aim at adopting the blockchain technology.

For commercial banks, distributed ledgers promise various advantages—but they also cause problems:

Instead of having to keep track of their assets in separate databases, as financial firms do now, they can share just one. Trades can be settled almost instantly, without the need for lots of intermediaries. As a result, less capital is tied up during a transaction, reducing risk. Such ledgers also make it easier to comply with anti-money-laundering and other regulations, since they provide a record of all past transactions (which is why regulators are so keen on them).

… Yet … [o]ne stumbling block is what geeks call “scalability”: today’s distributed ledgers cannot handle huge numbers of transactions. Another is confidentiality: encryption techniques that allow distributed ledgers to work while keeping trading patterns, say, private are only now being developed. … Such technical hurdles can be overcome only with a high degree of co-operation …

Meanwhile, central banks plan digital currencies built around the same technology.

Like bitcoin, these would be built around a database listing who owns what. Unlike bitcoin’s, though, these “distributed ledgers” would … be tightly controlled by the issuers of the currency.

The plans involve letting individuals and firms open accounts at the central bank …

Central banks … could save on printing costs if people held more bits and fewer banknotes. Digital currency would be tougher to forge, though a successful cyber-attack would be catastrophic. Digital central-bank money could even, in theory, replace cash. …

Better yet, whereas bundles of banknotes can be moved without trace, electronic payments cannot. … The technology first developed to free money from the grip of central bankers may soon be used to tighten their control.

Stiff Competition for Brokerage Firms

The Economist reports about the “ostensibly free online services” provided by Robinhood, a share-trading app.

Instead of taking commissions from customers, Robinhood receives them from the trading venues to which it steers their orders, a controversial but common practice. It also earns returns from the cash clients leave in their accounts, and plans soon to offer margin trading—the buying of stock with borrowed money—for which it will charge a fee.

Earlier posts on fintech.

Ethereum

Ethereum

is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference.

These apps run on a custom built blockchain, an enormously powerful shared global infrastructure that can move value around and represent the ownership of property. This enables developers to create markets, store registries of debts or promises, move funds in accordance with instructions given long in the past (like a will or a futures contract) and many other things that have not been invented yet, all without a middle man or counterparty risk.

Mervyn King on Narrow Banking and Liquidity Insurance

In the FT, John Plender reviews Mervyn King’s “The End of Alchemy: Money, Banking and the Future of the Global Economy.” King diagnoses two problems underlying the crisis. First,

Interest rates today, he says, are too high to permit rapid growth of demand in the short run but too low to be consistent with a proper balance between spending and saving in the long run. The disequilibrium persists, as does a misallocation of capital to unproductive investments.

The second problem relates to the financial system and

the alchemy that runs through the financial system, whereby governments pretend that paper money can be turned into gold on demand and banks pretend that the short-term deposits used to finance long-term investments can be returned whenever depositors want their money back. …

King argues that Bagehot’s famous dictum on central bank crisis management — lend freely on good collateral at penalty rates — is out of date because bank balance sheets today are much larger and have fewer liquid assets than in the 19th century. Central banks are thus condemned in a crisis to take bad collateral in the shape of risky, illiquid assets on which they will lend only a proportion of the value, known as a haircut.

King suggests this lender of last resort role should be replaced by … a pawnbroker for all seasons. In effect, he offers an elegant refinement of the concept of “narrow banking”, which seeks to ensure that all deposits are covered by safe, liquid assets. In his system, banks would decide how much of their asset base to lodge in advance at the central bank to be available for use as collateral. For each asset, the central bank would calculate a haircut to decide how much to lend against it. Together with banks’ cash reserves at the central bank, this collateral would be required to exceed total deposits and short-term borrowings.

This central bankerly pawnbroking would facilitate the supply of liquidity, or emergency money, within a framework that eliminates the incentive for bank runs. It amounts to a form of insurance whereby the central bank can lend in a crisis on terms already agreed and paid for upfront …

The system would displace what King regards as a flawed risk-weighted capital regime ill-suited to addressing radical uncertainty. Today’s liquidity regulation would also become redundant. But banks would still need an equity buffer, with King seeing an equity base of 10 per cent of total assets as “a good start”, against the 3-5 per cent common today.

The current shortfall of fully liquid assets against deposits — the alchemical gap — could be eliminated progressively over 20 years, during which time the expectation would grow that banks would no longer be bailed out. The system would apply to all financial intermediaries …

Update: The Economist‘s reviewer writes:

… Lord King wants banks to buy “liquidity insurance”. In normal times banks would pledge collateral to the central bank, which would agree to lend a certain amount against it, if necessary. Banks would thus know in advance precisely how much help they could get in the event of a meltdown, making them behave responsibly when times were good.

Not Guilty of Money Laundering, but Out of Business Anyway

The Economist continues to report critically on US regulatory pressure abroad and possible double standards.

The Financial Crimes Enforcement Network (FinCEN), part of America’s Treasury, [has] rescinded a devastating finding against a European bank suspected of facilitating money-laundering. The withdrawal, less than a year after the designation, looks like a climbdown. …

Some suspect the bank was a pawn in a tussle between governments: miffed that Andorra was slow to adopt American-style anti-money-laundering rules … America decided to show who was boss by selecting a bank to pick on. There is some evidence to support this sacrificial-lamb theory. … an American diplomat suggested that America chose to “use the hammer” on BPA as a way of resolving wider concerns about Andorra. …

These cases highlight two problems with FinCEN’s money-laundering cudgel. The first is double-standards. It tends to go after only small banks in strategically unimportant countries … The second is its lack of openness. It faces no requirement to make detailed evidence public, or even available to a court, at the time of action. By the time any challenge is heard, it may be too late for the bank in question.

Report on the Irish Banking Crisis (And the ECB’s Role)

In the Irish Times, Colin Gleeson summarizes the findings and recommendations of the main Report of the Oireachtas Banking Inquiry. They are:

  • Incentives were distorted.
  • Banks and the property sector ran out of control.
  • Regulators were too optimistic.
  • “IMF favoured imposing losses on senior bond holders in October/November 2010.”
  • “No Troika programme agreed in November 2010 if Government burned senior bond holders.”
  • “ECB position contributed to inappropriate placing of significant banking debts on Irish citizens.”

Banks’ Debt Valuation Adjustments Will End

In the FT, Ben McLannahan reports about a change in US accounting standards concerning the valuation of bank debt.

Under the rules in place since 2007

banks were allowed to use market prices when valuing their own debt, meaning they could book profits when their debt fell in value and losses when it rose.

Particularly during the financial crisis this led to sizable effects of swings in debt prices on bank profits. Under pressure from financial institutions, the Financial Accounting Standards Board “threw in the towel” and follows the International Accounting Standards Board which already backtracked in 2014. Under the new rules the debt valuation adjustments are expected to become more or less irrelevant.

The intention of the 2007 rules was clear:

… if banks were going to book their assets at market value, rather than cost, they should also book their liabilities at market value. Companies should therefore be allowed to recognise gains when the value of their bonds fell below par, the FASB reasoned, on the assumption that they would be able to buy them back at a discount.

But this implied that banks “booked income in bad times and expenses in good times.”

Banks Face Wipeout in some Financial Services

In the FT, Martin Arnold summarizes a McKinsey study on banking. Arnold entitles his article “McKinsey warns banks face wipeout in some financial services.”

According to the report, competition arises from technology companies that deliver specific financial services at much lower cost.

McKinsey said technological competition would reduce profits from non-mortgage retail lending, such as credit cards and car loans, by 60 per cent and revenues by 40 per cent over the next decade. … It predicted a smaller, but still significant, chunk of profits and revenues would be lost from payments processing, small and medium-sized enterprise lending, wealth management and mortgages. These would decline between 35 and 10 per cent, McKinsey said.

See my previous posts on structural change in banking and fintech competition for banks.

The Brussels Agreement of 13 July 2015

Graeme Wearden in The Guardian summarizes the results of the Euro summit that ended with no Grexit:

An agreement has finally been reached in Brussels after almost 17 hours of talks, Europe’s longest-ever summit. A deal on the new bailout for Greece has still to be thrashed out, however. Here are the key points:

Greek assets transfer

Up to €50bn (£35bn) worth of Greek assets will be transferred to a new fund, which will contribute to the recapitalisation of Greek banks. The fund will be based in Athens, not Luxembourg as the Germans had originally demanded.

The location of the fund was a key sticking point in the marathon overnight talks. Transferring the assets out of Greece would have meant “liquidity asphyxiation”, said the Greek prime minister, Alexis Tsipras.

Bridging finance

Talks will begin immediately on bridging finance to avert the collapse of Greece’s banking system and help cover its debt repayments this summer. Greece must repay more than €7bn to the ECB in July and August, before any bailout cash can be handed over.

Debt restructuring

Greece has been promised discussions on restructuring its debts. The German chancellor, Angela Merkel, said the Eurogroup was ready to consider extending the maturity on Greek loans. There is now no need for a Plan B, she added.

New legislation

The Greek parliament must approve the deal before the German bundestag votes. It must also start passing legislation straight away to implement the agreed measures.

Creditors have insisted on immediate action on:

  1. Streamlining VAT
  2. Broadening the tax base
  3. Making further reforms to the pension system
  4. Adopt a code of civil procedure
  5. Safeguarding of legal independence for Greece ELSTAT — the statistic office
  6. Full implementation of automatic spending cuts
  7. Meet bank recovery and resolution directive

Radical reforms

Tsipras pledged to implement radical reforms to ensure that the Greek oligarchy finally makes a fair contribution. The agreement thrashed out overnight would allow Greece to “stand on our feet again”.

Implementation of reforms would be tough, the Greek prime minister said, but: “We fought hard abroad, we must now fight at home against vested interests.”

He added: “The measures are recessionary, but we hope that putting Grexit to bed means inward investment can begin to flow, negating them.”

Updates and additional links

More from the Guardian. An assessment by an analyst.

The official Euro summit statement.

Major IMF-Internal Disagreement Preceded the First Greek Bailout

At the 9 May 2010 meeting at which the IMF board approved the first bailout program for Greece, not all members approved. In fact, many members, including the Executive Director representing Switzerland, challenged the proposal, suggested less optimistic scenarios and asked for modifications. The Wall Street Journal published excerpts of the minutes in October 2013, see below.

Sebastian Bräuer in the NZZ am Sonntag also reports on the issue. He points out that the Swiss Executive Director asked what would happen if the Greek government were not to implement the agreed reforms; and if IMF and European commission were to disagree. Bräuer also reports that some European banks would have been prepared to bear losses resulting from their Greek exposure, see below.

The WSJ writes:

Swiss executive director Rene Weber in a prepared statement to the board for the May 9, 2010 meeting: We have “considerable doubts about the feasibility of the program…We have doubts on the growth assumptions, which seem to be overly benign. Even a small negative deviation from the baseline growth projections would make the debt level unsustainable over the longer term…Why has debt restructuring and the involvement of the private sector in the rescue package not been considered so far?”

“The exceptionally high risks of the program were recognized by staff itself, in particular in its assessment of debt sustainability.”

“Several chairs (Argentina, Brazil, India, Russia, and Switzerland) lamented that the program has a missing element: it should have included debt restructuring and Private Sector Involvement (PSI) to avoid, according to the Brazilian ED, ‘a bailout of Greece’s private sector bondholders, mainly European financial institutions.’ The Argentine ED was very critical at the program, as it seems to replicate the mistakes (i.e., unsustainable fiscal tightening) made in the run up to the Argentina’s crisis of 2001. Much to the ‘surprise’ of the other European EDs, the Swiss ED forcefully echoed the above concerns about the lack of debt restructuring in the program, and pointed to the need for resuming the discussions on a Sovereign Debt Restructuring Mechanism.”

“The Swiss ED (supported by Australia, Brazil, Iran) noted that staff had ‘silently’ changed in the paper (i.e., without a prior approval by the board) the criterion No.2 of the exceptional access policy, by extending it to cases where there is a ‘high risk of international systemic spillover effects.’”

The NZZ writes:

[Swiss ED Weber asked:] “Wie reagiert der Fonds, wenn die Behörden die Sparmassnahmen und Strukturreformen nicht umsetzen?”

[IMF-deputy John Lipsky said:] “Es gibt keinen Plan B. Es gibt einen Plan A und die Absicht, dass Plan A erfolgreich ist.”

“Ich kann die Direktoren informieren, dass deutsche Banken Unterstützung für Griechenland erwägen”, sagte der deutsche IMF-Direktor Klaus Stein. Sein französischer Kollege Ambroise Fayolle ergänzte, auch die Banken seines Landes würden ihren Job tun.

Arguments in Favor of ELA to Greece

Martin Hellwig argues in the Handelsblatt that the ECB should not cut Emergency Liquidity Assistance (ELA) to the Greek central bank. He makes the following points:

  • In 2010, the ECB pressured Ireland to guarantee bank liabilities (vis-a-vis other European banks) by threatening to cut ELA. Such blackmailing is inconsistent with the ECB’s task to safeguard cash and payment systems.
  • The same applies to Greece now. As lender of last resort, the ECB should provide funding to Greek banks even (or exactly) when they don’t have access to markets, as long as they are solvent. In principle, the banks may use central bank funding for whatever purpose they see fit; right now, however, the ECB has put restrictions on Greek banks’ purchases of Greek government bonds.
  • Are the Greek banks solvent? There are certainly liquidity problems, due to heavy withdrawals triggered by fears that the Greek government may convert Euro into Drachma denominated deposits. Solvency problems are only very recent, due to the economic malaise.

At this point Hellwig stops arguing based on the European treaties.

  • Instead, he suggests that the solvency rule could be waived in situations like currently in Greece or in Germany in 1931.
  • He concedes that a freezing of ELA could be considered a precautionary measure against Grexit—an event that is not anticipated in the European treaties.
  • But it could also be considered a measure that forces Greece into economic turmoil; the Greek banks into insolvency; and Greece out of the Euro area against its will.

The Greek Bank Holiday and Capital Controls

Saturday, 27 June 2015 and earlier:

  • In a Medium blog post, Karl Whelan provides an excellent discussion of the policy mistakes that worsened the Greek debt crisis.
  • Hans-Werner Sinn’s “The Greek Tragedy.”
  • Alex Barker discusses in the FT the options for Greece’s banking system.

Sunday, 28 June:

  • Christian Rickens comments in Der Spiegel that the upcoming Greek referendum is the price to pay for five years of cowardice, both on the part of the Greek government and its European partners.
  • The FT summarizes the main policy decisions during the last days that led the Greek economy to “hit a roadblock.”
  • The Economist writes that “[I]n these circumstances a cap on ELA must mean tough restrictions on deposit withdrawals both in cash and through transfers abroad.” It draws parallels to Cyprus in March 2013 where banks closed for two weeks and where capital controls were recently lifted.
  • Ekathimerini reports about the decision to close the banks and instate capital controls. It quotes the Greek prime minister as saying that “[Rejection] of the Greek government’s request for a short extension of the program was an unprecedented act by European standards, questioning the right of a sovereign people to decide. … This decision led the ECB today to limit the liquidity available to Greek banks and forced the Greek central bank to suggest a bank holiday and restrictions on bank withdrawals. … One thing is clear: the refusal of a short extension, and the attempt to nullify a democratic procedure is an act deeply offensive and shameful for the democratic traditions of Europe.”

Monday–Tuesday, 29–30 June:

  • Claire Phipps summarizes in The Guardian the main elements of the ‘Bank Holiday break’ decree that the Greek prime minister and president enacted during the night, in response to “the extremely urgent and unforeseen need to protect the Greek financial system and the Greek economy due to the lack of liquidity caused by the Eurogroup’s decision on June 27 to refuse the extension of the loan agreement with Greece”.
  • Philip Stafford and Roger Blitz speculate in the FT about the implications of Grexit. (See also the earlier post on Lex Monetae.)
  • The FT’s liveblog.
  • In the FT, Martin Sandbu convincingly addresses questions on the bigger picture, including political aspects of the crisis.
  • Anil Kashyap has published “A Primer on the Greek Crisis.”
  • In the FT, Shawn Donnan discusses the consequences of a Greek default against the IMF.
  • Der Spiegel reviews how the international press assigns responsibility for the crisis.

Wednesday, 1 July:

  • In the FT, Peter Spiegel outlines the way forward to a new “Greek” bailout.
  • The Economist’s Free Exchange blogger on the limited experience with capital controls (Iceland, Cyprus, now Greece).

Note: This post has been updated repeatedly.

Charles Ferguson’s “Inside Job”

Charles Ferguson’s movie Inside Job portrays as

  • evil: Feldstein, Hubbard, Paulson, Rubin, Summers, Wall Street, … ;
  • clueless or not convincing: Bernanke, Campbell, Geithner, Greenspan, Mishkin, Portes, … ;
  • aware (at least ex post): Buiter, Johnson, Lagarde, Lo, Partney, Rogoff, Roubini, Strauss-Kahn, Tett, Wolf, … .

Economics and economists are considered part of the problem rather than the solution. While the movie

  • depicts Ragu Rajan as the hero,

it is silent about the fact that Rajan is one of the most prominent economists.

Banks Are Not Intermediaries of Loanable Funds

In a recent Vox blog post, Zoltan Jakab and Michael Kumhof argue that macroeconomic models where banks intermediate loanable funds get it seriously wrong.

In the intermediation of loanable funds model, bank loans represent the intermediation of real savings, or loanable funds, between non-bank savers and non-bank borrowers … [but in reality] [t]he key function of banks is the provision of financing, meaning the creation of new monetary purchasing power through loans, for a single agent that is both borrower and depositor.

This difference has important implications. Compared to intermediation of loanable funds models, money creation models predict larger and faster changes in bank lending and real activity; pro- or acyclical rather than countercyclical bank leverage; and quantity rationing of credit after contractionary shocks. New loans in loanable funds model are accompanied by additional savings and thus, higher production or lower consumption. In money creation models, in contrast, they simply reflect an expansion of banks’ balance sheets that is only checked by profitability and solvency consideration. Moreover, “the availability of central bank reserves does not constitute a limit to lending and deposit creation. This … has been repeatedly stated in publications of the world’s leading central banks.”

A large part of [money creation banks’] response [to a contractionary shock], consistent with the data for many economies, is … in the form of quantity rationing rather than changes in spreads. … In the intermediation of loanable funds model leverage increases on impact because immediate net worth losses dominate the gradual decrease in loans. In the money creation model leverage remains constant (and for smaller shocks it drops significantly), because the rapid decrease in lending matches (and for smaller shocks more than matches) the change in net worth. … As for the effects on the real economy, the contraction in GDP in the money creation model is more than twice as large as in the intermediation of loanable funds model, as investment drops more strongly than in the intermediation of loanable funds model, and consumption decreases, while it increases in the intermediation of loanable funds model.

A Plan for Greece

In the FT, Willem Buiter proposes a 5 point plan for a way out of the Greek debt crisis:

  • Greece effectively regains sovereignty and can do whatever it pleases, with some exceptions, see below.
  • Greek debt held by the ECB is bought by the ESM: The ESM extends long-term, low-interest financing to Greece which Greece uses to repay the ECB debt. “Since most of Greece’s other sovereign liabilities have long maturities and deferred interest payments, payments to creditors would fall sharply.”
  • No further financing by the IMF, the ESM or other official sources is extended to Greece.
  • The ECB does no longer accept any Greek government debt paper as collateral or for purchase.
  • Commercial banks in Greece are recapitalized or restructured using funds from the Hellenic Financial Stability Fund and other sources. The ECB bars Greek banks from accepting any Greek government debt paper.

The plan would require additional European taxpayer money for the ECB-ESM debt swap and the bank recapitalization. It would isolate the Greek banks from the mayhem triggered by government default.

Update: 7 July 2015

A related proposal by Willem Buiter and Ebrahim Rahbari.

IMF Research and Greece

Ashoka Mody argues in an Econbrowser blog post that recent IMF research should guide a Greek deal. According to Mody this research shows that debt overhang is very costly; “austerity” can be self defeating; and structural reforms generate uncertain payoffs. He therefore recommends

  • large scale debt relief, resulting in a debt quota of 50%,
  • a scale down of the banking system, and
  • a primary surplus quota of 0.5% over the coming years.

Olivier Blanchard, IMF chief economist, disagrees.

Top Bank Executives Sell Shares

Tom Braithwaite reports in the FT that it is no longer unheard of for top bank executives to sell shares of the institutions they manage—shares they presumably received to improve incentives. To the contrary. Some executives even sold at surprisingly low prices:

Some have done so beneath “book value”, a measure of how much of a company would be left for shareholders if it were liquidated. Companies trading at this level are either undervalued by the market or overstating the value of their assets.

Greece Benefited from Troika Support

In a Vox column, Jeremy Bulow and Ken Rogoff argue that perceptions of Greek net debt repayments over the last years are wrong.

[C]ontrary to widespread popular opinion, the net flow of funds (new loans and subsidies minus repayments) went from the Troika to Greece from 2010 to mid-2014, with a modest flow in the other direction after Greece stalled on its structural reforms.

They also make some other points:

  • Cash withdrawals, non-performing loans and capital losses in the wake of the 2012 Greek government debt default hurt the Greek banking system.
  • Mistrust of the Greek government by European partners and Greek citizens slowed down the recovery.
  • Greece has incentives to avoid a default on its official loans since default might trigger lower EU subsidies; the loss of other benefits of EU membership; less ELA funding and other forms of financing at below market rates. (Harris Dellas and I have argued the same in our paper Credibility for Sale.)
  • As Greece approached the point of being a net payer its bargaining stance hardened.

“Leben ohne Bargeld (Life without Cash),” SRF, 2015

SRF, Echo der Zeit, May 18, 2015. AUDIO, HTML.

  • The availability of cash has costs: It eases tax evasion and money laundering and obstructs monetary policy at the zero lower bound.
  • But it also has benefits.
  • And the zero lower bound constraint can be relaxed otherwise, using taxes or an exchange rate.

Removing the Zero Lower Bound on Interest Rates

Imperial College London (the business school’s Brevan Howard Centre), CEPR and the Swiss National Bank organized a conference on this topic in London.

Most of the speakers agreed that giving central banks the option to move interest rates much further into negative territory would be valuable; and that deposit rates lower than minus half a percent p.a. are difficult to sustain without triggering major cash withdrawals. There was less agreement on how to avoid such withdrawals. Some favored phasing out cash, as this would also render tax evasion and money laundering more difficult; others were unwilling to sacrifice the privacy benefits of cash. But many speakers emphasized that there are other possibilities to achieve the same objective. (See my earlier blog post.)