US President Barack Obama recently announced perhaps his most controversial and populist action; new taxes on banks and restrictions on proprietary trading.
This new phase stems not from a crisis in banks, but the opposite; a quick rebound of global banking profits. This has precipitated a new problem for banks; a political problem based on the feeling they got off lightly after being saved by taxpayers, and a simultaneous structural problem that banks have grown too big to fail.
Banks have been on a new spree, using the cheap money offered to harvest large profits in the midst of a supposed downturn, and the public is furious, particularly when they hear of the return of the super-bonuses.
The practice of banking might be complex but its basis is simple. Banks borrow short and lend long, so are always vulnerable to sudden collapse, and the question is how to prevent that happening.
Obama’s answer is to tax them and use this money to provide an increased level of insurance, while reining them in to limit the size of the crisis should they fail. Conceptually this is unimpeachable but in practice it’s a headache.
Obama promised that never again would the American taxpayer be held hostage by a bank that is “too big to fail”.
The definition of proprietary trading is difficult to determine. The reason proprietary trading is not broken out is that it’s one of investment banks’ big secrets. Essentially it is the amounts a bank invests on its own account as opposed to those it invests for clients. Yet the information that motivates these amounts is often gleaned from client relationships. Hence, if a client asks for a loan to buy two new huge coal power stations, you can be sure someone on the proprietary trading desk is buying up a small mountain of coal futures.
In a sense, investment banks practise a sort of information front-running; not actually slapping a big trade on before prior to a big institutional buy, but using information that is not generally known to achieve more or less the same effect. Yet what is the difference between proprietary trading and providing a client with liquidity to hedge, for example? Say a client wants to hedge the platinum price, a bank needs to pick up the other side of the hedge. That requires a deep and liquid platinum futures market. In trying to clip banks’ wings, Obama may inadvertently make markets shallower and so more volatile.
In any event, what is to stop a bank locating a proprietary desk in a different entity or locality? Essentially, hedge funds are prop desks gone private and could be located in banking hideaways, as many are. This might actually help some of Obama’s problems, as it would help address the “too big to fail” conundrum. But it creates new ones as it’s not only banks that are too big to fail, but also insurance companies.
Against this background, the Basel banking committee issued new liquidity measures in December to address some structural issues. The proposal includes the familair overall liquidity ratio and two new ratios. The liquidity coverage ratio measures the ability of a bank to survive a severe liquidity squeeze for 30 days. The net stable funding ratio assesses the stability of a bank’s funding relative to the liquidity profile of the assets. The Basel committee proposes a minimum target of 100% for both ratios.
See the Obama plan details and an explanation of how it is likely to affect the US banking sector in the Financial Times graphic.
