Sunday, November 24, 2013

The Future of Finance – A Q&A session about happy clients, skepticism, profitable ethics, capital market intermediation, shadow banks, simplicity and technology

On October 12, the Institute of International Finance held a “CEO masterclass about the future of finance”. The pretentious title turned into a very interesting discussion about the state of the universal banking industry and its outlook for tomorrow. Here are the essentials:

Are big and global universal banks necessary?

Jamie Dimon says yes, simply because “clients need the services”. As the financial system and its products are complex and big corporates acting cross-border, banks simply mirror this situation and become big and complex.

Our clients are quite happy with us.”
Jamie Dimon (JP Morgan)

Do universal banks respect ethics?

The statements are somewhat mixed. The opinions range from downplaying scandals to alarming the industry.

We have a series of issues and we are gonna deal with them. But that doesn’t my bankers immoral.”
Jamie Dimon (JP Morgan)

The fundamental contract between financial services and society stands bruised and perhaps broken” Anshu Jain (Deutsche Bank)

Global universal banks are at the heart of skepticism.”
Anshu Jain (Deutsche Bank)

We [global banks] have to earn the license from civil society every day. Just saying, shareholders are happy and clients are happy, will not be enough.”
Piyush Gupta (DBS)

Ethics is very profitable at the end of the day.”
Francisco Gonzalez (BBVA)

Have universal banks changed since the 2008/09 financial crisis?

Yes, the regulatory changes have been substantial.

BNP Paribas, like any other bank, has more changed in the last five years than in the last 150 years.”
Baudouin Prot (BNP Paribas)

Are universal banks dangerous?

No. First, they have, since the financial crisis, increased significantly the equity portion of their balance sheets. Second, proprietary trading is usually not a significant portion of the banks’ balance sheets.

I am not worried because leverage has gone down dramatically.”
Anshu Jain (Deutsche Bank)

The whole system is fare safer.”
Jamie Dimon (JP Morgan)

Is credit intermediation in Europe gaining place?

This is unclear. On the one hand, the speakers outline the growing importance of capital markets in Europe.

We will absolutely need universal banks like BNP Paribas that bring corporate clients for the first time to the bond markets.”
Baudouin Prot (BNP Paribas)

It’s very important to reduce that dependence [of the European economy] on banks.”
Anshu Jain (Deutsche Bank)

Whether we like it or not, in Europe, we have to migrate to a system where the banks’ balance sheets will be smaller, as a percentage of the funds provided to the economy, and we need to have more market mechanisms.”
Frédéric Oudéa (Société Générale)

On the other hand, Anshu Jain says that “European confidence in [financial] markets is even lower than European confidence in its big banks.” The consequence is that “instead of capital market intermediation now becoming a stronger force, it’s actually a weaker place.”

What is most important when it comes to regulation of global universal banks?

Most important is that national regulators treat banks equally. This is the famous level playing field.

If we want to have a level playing field we need the rules in terms of capital and liquidity requirements but also for derivatives to be the same [in Europe and the U.S.].”
(Anshu Jain (Deutsche Bank).

Are shadow banks bad?

It will not surprise you that you won’t get a simple “yes” or “no” answer here. On the one hand, the speakers want to cool down worries about the shadow banking system.

Just because they [clients] go to the shadow banking system doesn’t mean that it’s bad.”
Jamie Dimon (JP Morgan)

On the other hand, they face the reality that regulating the regular banking system is, to some extent, useless, if the shadow banking system remains unregulated.

As you make banks safer, you cannot simultaneously remain suspicious and want to move activities away from them [to the shadow banking system].”
Anshu Jain (Deutsche Bank)

Risk is a zero sum game. It has to sit somewhere.”
Anshu Jain (Deutsche Bank)

Will / should the shadow banking sector be regulated?

Yes, it will be regulated, simply because the regulator will follow the risk. However, the lecturers believe that the regulators should be more cautious as to the consequences of new regulation and regulate financial products rather than the stakeholders creating and selling them.

I think the regulators are coming. They are going to follow the risk [towards the shadow banking sector]. But it’s gonna take some time.”
Nicolas S. Rohatyn (The Rohatyn Group)

We want to solve the problems of the last crisis and we don’t understand the problems we are creating [by doing so].”
Alan D. Schwartz (Guggenheim Partners)

You have to think much harder about how to regulate the products and who’s got skin in the game.”
Alan D. Schwartz (Guggenheim Partners)

Can we make banking / financial products simple?

In principle no as banking is, by definition complex. However, the speakers seem to strive for simplicity even though it seems to be out of reach.

As Albert Einstein said: ‘You should make it [the financial system] as simple as possible, but no simpler.’)”
Jamie Dimon (JP Morgan)

There is this trend towards the desire for simpler instruments in a world in which you understand less.”
Nicolas S. Rohatyn (The Rohatyn Group)

People are gonna look for simpler instruments.”
Nicolas S. Rohatyn (The Rohatyn Group)

Will financial hubs play a vital role in the future?

Yes. The reason is that they allow efficient clearing of transactions. As you might expect, fiscal or (lack of) transparency considerations don’t play a role here.

Flows need and tend to congregate in places where efficient clearing mechanisms and efficient aggregation mechanisms are.”
Piyush Gupta (DBS)

I take it for given that financial centers have to develop based on technology and competitiveness but not on lack of transparency and things like that.”
Frédéric Oudéa (Société Générale)

Is the location of its headquarters still important for a global universal bank?

Yes, because “there is always a link between a country [the home country of the bank] and a bank.” – Frédéric Oudéa (Société Générale)

It’s, by nature, very important to be strong in our home market.”
Frédéric Oudéa (Société Générale)

How can global universal banks create a competitive advantage?

Generally, it’s by allocating capital properly.

With the regulatory framework today, you cannot afford to mis-allocate capital.”
Frédéric Oudéa (Société Générale)

How profitable can be big global banks?

New regulation for banks makes it more and more difficult for banks to remain profitable.

It is very difficult to be reasonably profitable in this new world.”
Frédéric Oudéa (Société Générale)

There is probably a prize that will be paid [by big banks] for size.”
Frédéric Oudéa (Société Générale)

This is especially true in retail banking.

It will be increasingly hard to find global players in retail banking […] because the economics don’t work and the regulations make it very complex.”
Piyush Gupta (DBS)

If you are too small in a country, it’s not easy to compete [in the retail banking market].”
Frédéric Oudéa (Société Générale)

Where will the industry head to in the coming years?

Corporate and commercial banks will become more and more global, whereas retail banks will become more regionally focused.

In the foreseeable future, you will see global corporate and commercial banks and you will see more regionally and entrenched consumer commercial banks.”
Piyush Gupta (DBS)

Technology is expected to further shake up the industry.

Technology is a game changer.”
Piyush Gupta (DBS)

I think people overlook or underestimate the importance of technology.”
Francisco Gonzalez (BBVA)

People are thinking in the short term. But in the medium or long term, there is a big threat to the banking system, and this is technology. Technology will give a completely different experience to our customers.”
Francisco Gonzalez (BBVA)

Dis-intermediation and expected consolidation in Europe and the opening up of the Chinese and Indian banking sector complete the current expectations for universal banks.

In Europe, you will see consolidation [in the banking industry over the next five years].
Frédéric Oudéa (Société Générale)

The barrier to entry CIB [corporate & investment banking] will be huge. To be profitable in CIB with all the [regulatory requirements] will request size.
Frédéric Oudéa (Société Générale)

It’s a question of time that the [Chinese] regulators will understand that having an old-fashioned, non-efficient financial system holds up the economy growing.”
Francisco Gonzalez (BBVA)


Thursday, November 14, 2013

ECB Note on the comprehensive assessment of the European banking system – Searching for 12 bn market capitalization!

On October 23, 2013, the ECB has published a note on its next year’s assessment of European banks. This has had a huge effect on European banks’ stock prices. They lost 12 bn € market capitalization, representing an average 2.7 %.

Is the ECB paper worth that much money? Let’s have a closer look.


With its assessment, the ECB wants to

  • enhance the transparency (namely the quality of the available information) of European banks’ condition;
  • repair, if and where needed, the condition of banks by taking corrective action;
  • build confidence in the soundness and trustworthiness of the European banking sector.

Process and timing

“The ECB will conduct the exercise, detailing its design and strategy, monitoring its execution in close cooperation with the NCAs [national competent authorities], performing quality assurance on an ongoing basis, collecting and consolidating the results and finalizing and disclosing the overall asset.”

The information content of this statement is almost 0 but we have gained 4 lines of reading the ECB note (and this post)!

After reading that Oliver Wyman will assist the ECB, in addition to national regulators, we learn that the assessment can be broken down into three sections:

  • Supervisory risk assessment: This addresses “key risks in the banks’ balance sheets, including liquidity, leverage, and funding”. The ECB will do quantitative and qualitative analysis based on backward and forward-looking information”.
  • Asset quality review: The review will be done on the basis of banks’ December 31, 2013 balance sheets. All asset classes and types of exposures are verified and, in addition, off-balance sheet assets included. More specifically the asset quality review will assess whether provisioning for credit exposures is adequate, determine whether the valuation of collateral for credit exposures is adequate, and analyze the valuation of complex instruments and high-risk assets on banks’ balance sheets. The three phases of the asset quality review are “portfolio selection (ensure that exposures with the highest risk are subject to in-depth review), execution (data integrity validation, sampling, on-site reviews of files, collateral valuation and recalculation of provisions and risk-weighted assets), and collation (final consistency exercise)”.
  • Stress test: The ECB will associate the EBA (European banking authority) in this exercise and “provide ad forward-looking view of banks’ shock-absorption capacity under stress.”

In terms of timing, the portfolio selection starts off in November 2013. The assessment shall be concluded by October 2014, prior to the ECB assuming its new supervisory task in November 2014.

Capital threshold

The comprehensive assessment applies an 8 % capital threshold. This means that risk-weighted assets should represent 8 % of Common Equity Tier 1 Capital. The 8 % figure breaks down in 4.5 % Common Equity Tier 1 ratio, 2.5 % capital conservation buffer, and a 1 % add-on for systemically relevant banks.

Follow up action

ECB’s assessment may lead to requirements for changes in bank’s provisions and capital. The bank might impose measures such as recapitalization, equity issuance, re-orientation of funding sources, and asset separation and sales.

List of banks

ECB writes, “The exercise covers 130 credit institutions in 18 member states, covering approximately 85 % of Euro area bank assets.”

A preliminary list of the banks covered by the ECB assessment is attached to the note. This is probably the most interesting part of the memo (at least for those institutions which did not expect to be selected).

In my view, the relevance of the ECB paper is pretty low. It seems that financial markets tend to over-react from time to time…


Thursday, November 7, 2013

U.S. Overseas Private Investment Corporation (OPIC) – Effective and efficient impact investing

OPIC’s approach to international development is effective and efficient: Effective because we operate with commercial discipline, and efficient because we generate income for the American taxpayer and the federal budget.”, writes Elizabeth L. Littlefield (President and CEO) in OPIC’s 2012 annual report.

Let’s have a closer look at what OPIC is and what it does.

About OPIC

OPIC is the U.S. Government’s development finance institution. Its 220 employees facilitate U.S. private investment in developing countries and emerging market economies.

OPIC refers to its investment practice as “impact investing”: It aims to transform capital into answers for common challenges such as access to education, financial inclusion, housing, healthcare, and climate change. At the same time, OPIC looks after generating sufficient returns on its investments to make the profitable.

As a consequence, the agency operates on a self-sustaining basis at no net cost to American taxpayers. Historically, every dollar of OPIC support has leveraged, on average, 2.60 USD in private sector investment.

OPIC supports projects in 103 countries in Sub-Saharan Africa, Middle East and North Africa, Asia, and Latin America. In terms of sectors, OPIC works in renewable resources (namely solar, wind, and geothermal power), agriculture (for example sustainable food production and clean water), infrastructure, SME lending, healthcare.

Development criteria

OPIC’s development matrix measures the developmental impact of projects across five key categories:

  • Jobs and human capacity building (How many and which type of jobs will the project create?)
  • Demonstration effects (Will the project result in the introduction of new products, services, business practices or production processes in the host country? Will it have a positive influence on the local regulatory or legal environment?)
  • Host country impact (Will the project procure local goods and services, generate export earnings, local taxes or other fees?)
  • Development reach (How many local people will benefit from the project?)
  • Environmental and community benefits


OPIC’s main products are

  • political risk insurance (covering inconvertibility of currency, expropriation, and political violence in the form of war, revolution, insurrection, etc.),
  • investment guarantees (covering risk of default for any reason and compensating principal and (fixed or floating rate) interest), and
  • direct loans.

Investment guarantees and direct loans are together referred to as “investment financing”. Such financing is only available for projects involving significant equity and/or management participation by U.S. businesses.


OPIC refinances its operations either through appropriations (i.e. direct allocation of federal funds to OPIC) or through borrowings from the US treasury. OPIC’s engagements are backed by a public fund and, in addition, pledged with full faith and credit of the United States of America.

OPIC Financials

OPIC’s political risk insurance business is stable; its investment financing business fluctuates significantly over time.

Direct loans outstanding have more than doubled since 2008.

Net income has experienced a stable increase on average in recent years.


  • OPIC Annual Report 2012

Saturday, November 2, 2013

Recognition and de-recognition of financial assets under IFRS 9 – The cow and its milk

To understand how to recognize and de-recognize financial assets on your balance sheet, imagine you have a cow

Recognition of financial assets

When is the cow yours? Under IFRS, it is yours, when you have the right to keep the milk it produces.

Turning back to financial assets, you recognize a financial asset on your balance sheet when you are entitled to receive its cash flows. IFRS accountants talk about “becoming party to the contractual provisions of the instrument”.

De-recognition of financial assets

When is the cow no more yours? Two scenarios are possible here – either the cow dies or your neighbor takes care of it.

1. The cow dies.

Under IFRS, you de-recognize a financial asset if “the contractual rights to the cash flows from the financial asset expire”.

2. Your neighbor takes care of the cow.

When you talk to your neighbor about your cow, you can take two approaches:

You can suggest selling the cow so that your neighbor takes care of it in his own hutch. Under IFRS, accountants talk about a “transfer of contractual rights to receive cash flows”.

Another possibility is to let the cow in your hutch and to continue feeding it. Your neighbor will nevertheless pay the price for the cow and, in return, receive the milk it produces, if any. Simply, you have to promise that you will not give your cow to someone else. After all, you cannot get paid twice for the same cow!

Substituting the cow for a financial asset, you will de-recognize a financial asset under five cumulative conditions:

  • You “retain the contractual rights to receive cash flows but assume a contractual obligation to pay those cash flows to one or more entities.” (You will milk the cow in the first place and then pass the milk to your neighbor.)
  • You are obliged to transfer cash flows only after their collection. (If there is no milk, your neighbor gets nothing.)
  • You commit not to “sell or pledge the original asset (other than a pledge for security purposes to the eventual recipient of the cash flows).” (Your neighbor can come and see his cow, nobody else.)
  • You engage to “remit received cash flows without material delay” and to “reinvest cash flows in cash or cash equivalents only.” (You have to give you neighbor the milk on the same day.)
  • You “transfer substantially all the risks and rewards of ownership of the financial asset” (In other words, you’re are no more exposed to a variability of the present value of future cash flows of the financial asset. You don’t care whether the cow produces milk or not. You were paid for it anyway.) or you transfer the control over the financial asset (In other words, you cannot sell the financial asset any more. As I wrote above, you cannot get paid twice for the same cow.).


  • IFRS 9, Chapter 3