December 11, 2013 6:59 pm

A safer financial system is now within our grasp

We have come too close to disaster to ignore the obvious lessons, write Paul Volcker and John Reed

Canary Wharf©Getty

Much has been written about the degree of progress in continuing financial reform. Too little credit, however, has been given to regulators for their efforts to impose a simple, commonsense, leverage restriction on our largest bank holding companies.

We all know the importance of robust capital standards in improving the loss-absorbing capacity of such highly complex, systemically important mega-institutions. In the run-up to the financial crisis, global capital requirements moved to a complex, model-driven approach that grossly understated risk. This aggravated the crisis just when capital support was most needed. Adding a simple leverage ratio based on the amount of tangible common equity a bank has in relation to its total assets – is an important step towards addressing the weakness of the existing system. The change should reduce the likelihood, and impact, of a big bank failure.

Of all the themes we see in financial crises and failures, one that recurs is leverageborrowing excessively to enhance returns. While great on the way up for aggressive investing and speculation, it is brutal on the way down. Not only will a highly leveraged business fail faster than a less leveraged one facing equivalent losses, its failure will have a greater systemic impact by transmitting potential losses to its counterparties. Add enough of it, and leverage can turn the safest investment into a recipe for sudden ruin when markets move.

We are pleased that US regulators are moving to apply a stronger leverage ratio in conjunction with a risk-based standard. While international regulators have agreed that leverage ratios of the largest banks should not drop below 3 per cent, US regulators have proposed doubling that to 6 per cent. (In other words, for every $100 in assets, banks must fund at least $6 with common equity.) Critics argue that this could create perverse incentives for banks to seek higher risk/higher yield assets. But such incentives can be addressed by using the standard alongside a robust system of risk weights. As each approach addresses the potential shortcomings of the other, using the two approaches in tandem is a prudent way to go.

The existing risk-basedcapital requirements have a number of shortcomings. Risk weightings are static; risk is dynamic. An asset perceived as safe one day can become risky the next. Regulatory judgments about risk are often tainted by analytic and political biases, incomplete information and the inherent uncertainties of economic forecasting. As a result, rules are overly complicated and filled with exceptions and carveouts that can create perverse incentives to favour certain assetsall while providing a false sense of security.

Adding a strong simple leverage ratio counters many of these shortcomings. It is easy to understand for management, boards, investors – and regulators. It is also comparable across companies, and in conjunction with a standardised risk-based system, difficult to game. A dual approach dramatically improves transparency about a company’s risk exposure and should allow investors and counterparties to perform apples-to-apples comparisons among large, complex institutions.

There is, however, one important caveat. In addition to raising the standards, as we on the Systemic Risk Council and other public interest groups have argued, one way to improve this approach is to fix our accounting regime to allow apples-to-apples comparisons between US institutions and their global counterparts.

Regulators have done a good job of trying to establish a leverage test to account for off-balance-sheet items given differences between US and international accounting standards, but convergence would be far superior. Many readers would be surprised just how leveraged many US institutions are, using the international standards.

The door to a safer, less leveraged financial system is half-open. We can open it wide by uniting standardised risk-based capital rules with leverage constraints, and common balance- sheet measures through convergence on global accounting standards.

The writers are former chairman of the Federal Reserve Board, and former chairman and chief executive of Citicorp and Citibank. Both are members of the Systemic Risk Council

Copyright The Financial Times Limited 2013.

viernes, diciembre 13, 2013



The Long March from the Third Plenum

Yu Yongding

DEC 11, 2013

Newsart for The Long March from the Third Plenum

BEIJINGThough China’s leadership succession was completed earlier this year, the policy agenda for the coming decade has only just been revealed. Following Chinese political tradition, the country’s new leadership had to wait for the Third Plenum of the Chinese Communist Party’s 18th Central Committee – held 3-4 quarters after the First Plenum, where the succession was sealed – to unveil its economic-policy priorities.

Third Plenums – and perhaps only Third Plenums – can bring about radical transformation. Indeed, it was at the Third Plenum of the CCP’s 11th Central Committee that Deng Xiaoping launched the reforms that opened up the Chinese economy and triggered more than three decades of rapid economic growth

The Third Plenums of the CCP’s 14th and 16th Central Committees – held in 1993 and 2003, respectively – also stand out. At both meetings, CCP leaders put forward comprehensive plans for the creation and perfection of the so-calledsocialist market economy” in China.

The 60-pointresolution” produced at the most recent Third Plenum covers six areas: the economy, the political system, the environment, culture, society, and Party capacity-building. This represents a significant departure from the agendas produced at previous Third Plenums, which focused exclusively on economic reform.

But, when it comes to economic-reform objectives, the resolution is not overwhelmingly innovative. Indeed, most of the goals that it includes – like reform of state-owned enterprises (SOEs), development of private enterprise, reduction of government intervention, protection of property rights, and creation of a modern market system – can be found in the resolution of the Third Plenum of the CCP’s 16th Central Committee.

Even the decision to redefine the market’s role in resource allocation as “decisive” was not the breakthrough that many observers have claimed. After all, the 2003 resolution had already defined the market as “fundamental” to resource allocation. Given this, the latest resolution’s most important implication is that it has dispelled any doubt about the new leadership’s commitment to the market-oriented reform that Deng initiated in 1978.

In line with tradition, the Third Plenum’s resolution did not discuss problems concerning growth and development, which one hopes the government will address in greater detail in the near future. That said, some of the resolution’s specific provisions for economic reform represent much-needed progress.

· SOEs will be required to deliver 30% of their profits to the state, instead of keeping most – or even all – of their profits, as they have done for the last two decades.

· Farmers will be granted more property rights, allowing them, for example, to transfer and mortgage land-use rights, though the government understandably continues to exercise caution about rural-land privatization.

· A real-estate property tax will be introduced, in order to suppress skyrocketing housing prices and reduce the vacancy rate – a controversial but perhaps necessary move.

· The one-child policy will be eased, allowing a couple to have two children if one parent is an only child. (Whether this change will be enough to reverse problematic demographic trends remains a topic of heated debate.)

· The government will “accelerate the reform of the household registration system,” in an effort to facilitate urbanization. But emphasis seems to have shifted to encourage coordinated development between urban and rural areas. While rural migrant workers will be encouraged to settle in small and medium-size cities, migration to metropolises will remain tightly controlled – or even be more strictly regulated.

But the resolution’s genuinely groundbreaking objectives lie in other areas. For starters, the resolution includes two potentially game-changing legal reforms. First, it emphasizes the government’s commitment to “respect and protect human rights,” prohibiting law-enforcement authorities from extracting confessions “by torture, corporal punishment, or abuse” and abolishing widely criticized programs for “re-education through the labor system.”

Second, in order to strengthen judicial independence, the resolution includes a call “to explore the establishment of judicial jurisdiction systems that are suitably separated from administrative areas.” In other words, the courts should be able to make decisions independently of the local governments that finance them.

In the political realm, the resolution includes measures to strengthen China’s so-calledconsultative democracy.” While the concept of enhancing the role of non-CCP forces in Chinese politics is not new, its prominence in the resolution reflects the Party’s willingness to adopt a more democratic political systemas long as it retains its dominant position, of course.

In a one-party system, meritocracy is a prerequisite for good governance, which in turn plays a central role in maintaining social stability. Unfortunately, meritocracy has been eroded by a political culture of sycophancy and cynicism. Designing a screening mechanism to minimize adverse selection in choosing bureaucrats and party officials has become one of the biggest challenges that China’s ruling elites confront.

Although the resolution’s general message is encouraging, a shopping list of reform objectives is not a strategic analysis of the contradictions that are undermining China’s development, let alone an action plan for responding to these contradictions. Indeed, for China’s new leadership, the successful completion of the Third Plenum is only the first step in a new long march toward a more stable, prosperous future.

Yu Yongding was President of the China Society of World Economics and Director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. He has also served as a member of the Monetary Policy Committee of the People's Bank of China, and as a member of the Advisory Committee of National Planning of the Commission of National Development and Reform of the PRC.

12/11/2013 03:15 PM

EU Wrangling

Berlin Plays It Safe on Banking Union

By Gregor Peter Schmitz

Germanys Finance Minister Wolfgang Schäuble (left) listens to his Lithuanian counterpart Rimantas Sadzius during a meeting in Brussels.REUTERS

Germanys Finance Minister Wolfgang Schäuble (left) listens to his Lithuanian counterpart Rimantas Sadzius during a meeting in Brussels.

If there's one notion at the core of the planned European banking union, it's that of playing it safe. The union has been designed to ensure that the financial markets will become more stable and that shareholders and creditors will be held more liable than taxpayers. And it is meant to ensure that Europe will be better armed if the European Central Bank comes across unexpected holes in balance sheets when it conducts stress tests this spring on the euro zone's 130 largest banks.

But when German Finance Minister Wolfgang Schäuble of the conservative Christian Democratic Union (CDU) party appeared before journalists just before midnight in Brussels on Tuesday, it became clear that things, once again, are anything but secure. Schäuble negotiated for close to 14 hours with his counterparts in Europe over the banking union, which many champions of the European Union believe is as epochal an event as the launch of the euro.

In the end, though, the issue was delayed until Dec. 18, when the finance ministers will meet again just before the regularly planned EU summit. "We're on the way towards achieving this," Schäuble told reporters, but the "political decision" can only be made in the coming weeks.

By then, it is highly likely that he will be installed again as finance minister in the new German government, to consist of a coalition of the Christian Democrats and the center-left Social Democratic Party. Still, it remains uncertain whether he will be able to present the banking union as some kind of gift marking the start of his new term in office by the end of the year.

Details Still Unclear about Liquidation Fund

The fact that the time frame is so narrow isn't just Schäuble's fault, although he is partly to blame. Tuesday's marathon negotiations were only the latest example of tactics by Berlin to block progress on EU issues. Annoyed EU representatives used the term "Germany's eternal litany" to describe negotiations on Tuesday.

The German government has recently signaled willingness to compromise on the issue of which body would be responsible for deciding if a bank needs to be liquidated. Initially, a newly created committee with representatives of national authorities would assume this responsibility, but the formal decision could then be left to an EU body like the European Commission. In disputed cases, the European Council, the powerful body that includes the leaders of the 28 member states, would be brought in to arbitrate.

Berlin has also agreed in principle to calls for a liquidation fund for failing financial institutions that would have a capacity of €55 billion ($76 billion) within 10 years. But the EU member states are supposed to agree among themselves on how these funds can actually be used, with greater voting weight being given to more populous countries. 

This idea hasn't gone over well with some governments, because they fear that Berlin, working together with a few small countries, would be able to block decisions. In addition, the money in the fund would not be available for use until it is transformed into an official EU instrument in 10 years' time.

Under the "liability cascade" plan being promoted by Schäuble, however, bank shareholders will be required to pay part of the costs for liquidating a bank starting in January 2016. Owners and creditors would first be required to cover any liquidation costs before any taxpayer money could be brought in. Berlin has had success so far in negotiations on this point. The German government had wanted to introduce this rule as early as 2015. But other member states like Italy pleaded for it to start at the earliest in 2018. They fear the move to start in 2015 might frighten investors.

And there's one additional play to safety: Germany continues to oppose using the European Stability Mechanism, the permanent euro-zone rescue fund, as a backstop for fledgling banks. Other countries have suggested employing the fund's billions of euros as part of a future banking union resolution mechanism.

'Institutional Skirmishing'

The amount of caution being exercised in Berlin, as well as the many fundamental legal questions the banking union has created in recent months, has surprised experts. "These details are of course important to Berlin, which fears (the union) could be challenged at the German Constitutional Court," Jacob Kirkegaard of the Peterson Institute for International Economics told SPIEGEL ONLINE. "Amid the institutional skirmishing, it appears as though Berlin has lost sight of the core idea of a banking union."

Among those ideas are that national banking supervisory authorities would no longer monitor national banks -- a principle that would be buried if Germany's savings banks and credit unions are excluded from EU supervisory as Berlin is planning. The second goal was to finally break the fatal link between banking crises and national crises. When Spain and Ireland were forced to back their financial institutions with billions of euros, the moves ruined their government budgets.

So will the planned scope of the banking union be able to fulfil these expectations? That's unlikely. The rescue of Anglo Irish Bank, which isn't particularly big, alone cost some €30 billion a few years back. A bailout on that scale would exhaust a huge chunk of the liquidation fund. "Even if these difficult negotiations finally end next week, what we will get at first is a mini-solution," said Kirkegaard.

German Finance Minister Wolfgang Schäuble met with his EU colleagues until midnight on Tuesday to discuss Europe's planned banking union. Berlin is playing it safe in the talks, but that hesitancy threatens to derail the project's core ambitions.

Is North Korea selling ‘large amounts’ of gold to China?

Author: Lawrence Williams

Posted: Wednesday , 11 Dec 2013

Reports out of the Republic of Korea say that North Korea is being forced to sell ‘large amounts’ of gold to China to help mitigate a domestic economic crisis.

LONDON (Mineweb) - Reports out of South Korea (ROK) suggest that North Korea is sellinglarge amounts’ of gold to China because of an economic crisis within the country. With South Korea always prepared to believe the worst of its northern neighbour, with which it is still technically at war, perhaps such claims should be viewed with a certain amount of scepticism – but with some undoubted cross border contacts the South Korean news agencies which reported the sales, may well have an inside track as to what is going on in the North – they are certainly better informed on their northern neighbour than anyone else.

While North Korea does not report its gold holdings to the IMF and thus do not appear in official statistics, reports back in 2007 suggested the country held gold reserves of around 2,000 tonnes, which would make it one of the world’s largest holders of the precious metalIndeed, if that figure is anywhere near correct then this is around double what China says it holds in reserves, although most people think China has been building its reserves to well above the official reported holding of 1,054 tonnes.

It is known that North Korea has a very longstanding gold mining industrysome put it as quite substantial and going back thousands of years – although whatquite substantialactually represents is uncertainIt is believed that the country’s largest gold mine may produce around 8 tonnes of gold a year and there are thought to be a number of smaller operations, but data are scarce.

If North Korea is indeed selling its gold to China then this could be considered quite significantperhaps not quite the economic collapse that some South Koreans would wish on their northern neighbour, but certainly signs of economic difficulties in perhaps maintaining its military might and weapons development programmes, let alone feeding its people

There have been times in the past where North Korea has been known to sell goldback in 1983-1993 around a ton a month of gold was sold through the LBMA and in 2006 there was a known gold and silver sale to Thailand, but otherwise the secretive nation has largely kept to its founder, Kim Il-sung’s declaration that the country should not sell any of its gold reserves North Korea is thus yet another Asian country with a strong belief in the value of its gold holdings as a key element in potentially supporting its global positionIf indeed it is selling gold out of reserves, perhaps in addition to newly mined gold, it does suggest that all is not well within the country on the economic front.

As such sales, if they are happening as reported, are likely to be government to government, then this could be another indicator that China is building reserves without reporting this to the IMFSuch sales are not an illogical proposition given that China’s continuing support is vital to the North Korean regime, yet the Middle Kingdom finds Korea’s often aggressive actions something of an embarrassment in its dealings with world leaders, so could be driving a hard bargain with the North Korean leadership to help underpin the regime.