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STRESS tests and Basel 3 - two catch phrases which make a journalist's blood run cold - have been the bane of my existence since last Friday.
So let's try and break it down for mere mortals who find Bloomberg news somewhat over-kill.
The US conducted its own stress tests on the banking sector last year, with 19 banks put through their paces at the height of the financial crisis.
It concluded that 10 of the largest needed about $75bn to pass their tests. That is all good and well, but according to the latest list from the Federal Deposit Insurance Corporation, 268 banks have failed in the US since January 2008. Of those, roughly 150 have failed post the stress tests.
Now, obviously in the bigger picture there is a huge difference between a major banking group - say Bank of America - failing and a community bank not making the grade, but if you are a depositor in any of those community banks you probably won't agree with the test results.
European regulators also wanted to appear proactive and last week released the results of their stress tests. They took 91 banks and passed 84 of them as sound. Fantastic, the crisis has been and gone!
Except for one issue - without being too technical, these European stress tests take it for granted that the sovereign or country will be good for its debts and won't default.
Ratings agencies lie low
Bearing in mind how much government debt there is out there at the moment, this is quite an assumption - especially when one thinks that when the US tested its banking system, it was banks which failed while when European banks are being passed, whole countries are on the brink of failing in one sense or another.
That brings us to the ratings agencies, which are now scared to make any major adjustments as they are still smarting from the criticism they took in 2008 and 2009.
I make no claim to being a ratings agency expert, but the following provides interesting reading. Last week ratings agency Moody's downgraded its outlook on Ireland from "stable" to "negative".
This was in line with other ratings including Standard & Poor's (S&P), which rated Ireland as AA in June 2009, after lowering it to AA+ from AAA in March 2009. If you talk to somebody invested in Ireland, they could have told you this a year ago when the country was just about bankrupt.
Then there is Greece. In January 2009 Greece's credit rating was downgraded from A-/A-1 to A/A-2 by S&P. It was then cut in December 2009 to BBB+, and in April 2010 it was downgraded to "junk".
That was quick. Experiences in the last few years have taught us that A ratings of any kind don't mean quite the same thing as they do in school or other kinds of evaluations - but it does make you a bit cynical.
A bond fund manager speaking in Johannesburg recently pointed out that one of the local metro councils had come to the bond market to raise money. Last year the metro council had about R400m in positive cash flow, this year it had R9m and yet its rating remained at AA2 and AA.
Anybody who tells you that credit analysts are sophisticated types may need their heads checked for basic common sense - or is that just me?
The basics of Basel 3
This issue of credit scoring brings me in full circle to Basel 3, supposedly part of the answer to the global financial crisis.
Basel 3 is established on three pillars. Simplistically, these are:
1. Is there real money in the bank your grubby traders are not using for "leverage"?
2. Separating operating and credit risk for regulators - ie where did you get the money from and what are you doing with it?
3. Did you cover yourself by releasing enough - not necessarily the right - information to the market?
Now bear in mind that Basel 2 recommendations were made in 2004, but didn't really sit well with banking groups which were making merry and leveraging themselves to the hilt. It has to be either mandatory or optional, but if it is optional stakeholders can't turn around and demand stress tests after a crisis, because they are meaningless.
Which brings me to my conclusion: common sense does not rule in the regulation of financial markets. Just this week I received (stole?) an analyst report from a big investment banking group, which mumbled something about how tweaks in the Basel 3 regulation might make Nedbank an attractive takeover target. Ah, so that is where those big headlines about takeovers come from!
However, the report concludes that Nedbank Group [JSE:NED] is probably not going to be taken over because the banking regulator isn't all that keen on it, it makes a fair whack of money for Old Mutual [JSE:OML] and even if it did sell it probably wouldn't get regulatory approval to move the money out of the country anyway.
Common sense, guys!
- Fin24.com
