The topic of whether or not Australian banks are well capitalised has been running hot. However the asset management sector has largely gone unnoticed when talking about financial system stability. In Australia, total assets held by asset managers (including superannuation funds, insurers and units trusts) are 75% of the assets held by banks. In fact the burning question at the moment when talking about asset management seems to be whether or not you need $1m to have a comfortable retirement. In addition, industry professionals vent plenty of frustration when talking about the apathy the Australian population seems to have towards saving for retirement. However this apathy could be one of the factors that mitigate the systemic risk from the asset management sector, according to this informative article from the RBA. (more…)
Recently Paul Fisher of the PRA gave a speech titled “Regulation and future of the insurance industry“. In it he says:
“Solvency II will introduce an enhanced system of governance standards – promoting the embedding of a strong risk culture, demonstrable within the day-to-day operations of insurers.”
Risk culture is big in risk management now. Prudential regulations started off being directive based, then evolved to principles based regulation. Post GFC we have beyond principles to risk culture. While companies and consultants talk about it, it is an ethereal concept.
A system of governance standards is certainly very useful as it gives a common set of principles for risk processes, policies and reporting that should exist. Rules and limits are also useful where management have requirements that are NOT subject to personal judgement. But can you “implement” risk culture?
To me risk culture exists where the organisation and people value and exercise traits such as prudence, inquiry, transparency and critical thinking. Risk culture makes standards effective. Sure, standards can help with risk culture by requiring that people do things like getting models reviewed and approved. However if people do these things only because of standards then the standards haven’t really created good risk culture…
According to the latest paper on governance from the Basel Committee, “Board members have responsibilities to the bank’s overall interests, regardless of who appoints them.” What does this mean? What are the bank’s “overall interests”? Board members are elected by the shareholders and are there to represent their interests – right? This statement seems to suggest that the authors believe there will be situations where the “overall interests” and shareholders’ interests diverge.
Previously I wrote about an approach to pricing loans, where the spread is set to cover expected losses from default, and to make a return on capital allocated. In this article I use the framework to explore the drivers of credit spreads that banks would calculate if they used the Basel IRB formula to calculate the amount of capital required.
Some banks may use regulatory capital to derive capital as this reflects the amount of regulatory capital required for the loan. The regulatory approach as specified by BCBS captures key drivers of risk such as probability of default, loss given default, systemic risk, and term.
This simple pricing approach reveals some interesting dynamics of the required credit spread. For example, with higher rated securities, the spread is driven by capital requirements and not the expected loss. Drivers of capital such as correlation between defaults and term to maturity have a larger influence.
In an earlier post, I talked about how banks set interest rates for loans compared to investors. I would like to explore the bank’s approach over a couple of posts. This post covers one approach to setting the interest rate to charge for a corporate loan.
The interest rate charged is:
- The cost of borrowing funds
- Expected cost of loan default
- Expense margin
- A rate of return on capital employed
Components of interest rate
The Basel Committee on Banking Supervision (BCBS) released a paper titled “A Sound Capital Planning Process: Fundamental Elements” in January 2014. This paper does not propose changes to standards or capital requirements. Instead, it reports on a study carried out by BCBS on the capital planning process at a number of banks.
The paper has a good overview of what is good capital planning and is worth reading if you work in bank capital management. It covers the following fundamental elements: internal control and governance, capital policy and risk capture, forward-looking view and management framework for preserving capital.
Banks must forecast future capital needs under a range of conditions as part of their internal capital adequacy assessment process (ICAAP). ICAAP is an part of Basel 2, Pillar 2 requirements. The BCBS document “Enhancements to the Basel II framework” outlined measures to strengthen Pillar 2 requirements. For Australian banks, the requirements are set out in Australian Prudential Regulation Authority’s standards and practice guides (APS 110 and CPG 110 respectively).
A number of the components of a sound capital planning process are already requirements under the current standards or guidance that Australian banks need to follow. (more…)
BBVA purchased financial technology start-up BankSimple for $117m in late February. I came across this news on a couple of blogs I follow: Jim Bruene from NetBanker and Ron Shevlin from Snarketing 2.0. Both have insightful posts on this deal.
Jim Bruene’s post has a link to Bank Simple’s presentation at Finovate’s 2011 Fall event. This video incorporates a short demo of BankSimple’s interface. BankSimple’s proposition is a simple and easy to use internet only banking product. It is not ground breaking. BankSimple offers a neater internet banking platform than most other banks. Some features are:
- A single interface for all products
- Natural language search capability for transactions
- Use of geo-spatial data and machine learning to better categorise and clean transactions.
In my view, BankSimple has taken some of the technology that is common place in e-commerce and search engines and incorporated it into a net banking platform. I can see most banks adding these features to their net banking platforms in the near future. As Ron Shevlin notes, the technology and the size of the deal would not qualify BankSimple as a major disruptor.
The fact is that BBVA paid $117m for something they could have built on their own for less. This is around $1200 per customer. Many commentators have speculated on why. Perhaps the value of brand, or to acquire the team that created Bank Simple. There is plenty of debate on the blogosphere on whether this was a good deal.
For me, this transaction highlights the growing focus on providing a seamless banking experience from both customers and banks. On one hand BankSimple had 100,000 customers who had consciously shifted from their current bank in search of an easier banking experience. On the other hand, BBVA felt it worthwhile to spend $117m to pick up BankSimple.