Libor, G-Sib charges and Metro Bank’s risk errors

The week on Risk.net, January 26–February 1, 2019

Metro Bank loan blunder perplexes industry

Bankers surprised risk-weight errors went unnoticed, warn they could harm bank’s IRB aspirations

Legislative fix sought for Libor fallbacks

Federal law makes it ‘almost impossible’ to change benchmark rates for FRNs

Unmoved, Fed stands by G-Sib surcharge

Facing down frenetic lobbying and even US Treasury, central bank doesn’t blink on surcharge

 

COMMENTARY: The Fed says ‘no’

One way of measuring the information content of a message is in terms of its entropy: to ask, in effect, how likely it was that the message would have said anything else. So, for example, a weather forecast of “hot and sunny tomorrow” would carry more information in Scotland – where anything from sun to fog to blizzard conditions is possible, often in the same day – than it would in Kuwait.

So the information content of complaints by the major US banks about the Federal Reserve’s surcharge on globally systemically important banks (G-Sibs) is probably fairly small. Naturally bank lobbyists will appeal for lower capital requirements and lighter regulation; that’s what they’re for.

The Fed’s blunt refusal to budge, however, carries a good deal more entropy. Lobbying against higher capital requirements has been constant since the first post-crisis reforms were mooted, and redoubled in April last year with the news that stress capital buffer and G-Sib surcharge were to be combined. The surcharge exists elsewhere – it’s part of the Basel III capital regulations – but in the US, banks have to calculate it using both the Basel method and the Fed’s slightly different method, and use the higher of the two.

This hasn’t been popular, and has led to loud and sustained complaints that US banks are now at a disadvantage to their foreign rivals. You might expect that, especially under the current finance-friendly and anti-regulatory America First government, this sort of argument would have a sympathetic hearing. Certainly Treasury secretary Steven Mnuchin has come in firmly on the side of the banks, recommending the Fed use only the Basel standard (while trying to weaken US regulation beyond Basel levels in other areas such as leverage).

But the Fed has remained unmoved. And there are two good reasons why this is the right move. First, as several members of Congress have pointed out, it’s not very obvious that US banks are actually groaning under the burden of excessive capital requirements. Their European rivals are struggling, but they themselves are posting record profits – even before the business-friendly tax cuts introduced last year by the US administration. Second, as former Federal Deposit Insurance Corporation vice-chairman Thomas Hoenig points out, it’s a regulator’s job to keep capital levels high rather than bowing to industry pressure – especially when macroeconomic headwinds are growing stronger.

 

STAT OF THE WEEK

Apple recorded just $9 billion of outstanding derivatives notionals – exclusively for foreign exchange contracts – in 2008. In the 10 years since, it has ramped up forex derivatives notionals to $128 billion (1,322%). In 2013, the firm started using interest rate derivatives and has grown notionals by $33 billion (1,000%) from $3 billion over the past five years – Apple derivatives use surges

 

QUOTE OF THE WEEK

“With today’s access to artificial intelligence open source libraries, any intern now can build a [tool] in a few days. Code has become faster to write. These kinds of tasks were not achievable five years ago. On the other side, the testing of an AI-based tool [takes] time. One must deeply study in which cases a neural network works, and in which case it does not work. The functional skill to do that is high and cannot be delegated. So it is becoming cheaper to build a tool, but much more expensive to test and industrialise it” – Joseph Mikael, EDF

Further reading

• Regulation

Basel haircut floors threaten securities financing desks

• 31 Jan 2019

• Markets

CVA study highlights scale and causes of wrong-way risk

• 30 Jan 2019

• Risk management

Large banks thrash regionals’ proposal on CECL

• 28 Jan 2019

• Commodities

AI moves into middle office at energy firms

• 28 Jan 2019

• Risk management

Model risk chiefs warn on machine learning bias

• 31 Jan 2019

• Markets

Hope fading for margin threshold hike

• 31 Jan 2019