Not Stickies

Basel III does a great job of reducing a bank’s ability to overstate or double count capital, however loopholes remain if regulators are co-operative.

Southern European countries are desperate to ensure their banks are adequately capitalised without having to inject taxpayer money. By guaranteeing to reimburse banks for deferred tax independent of whether the bank is profitable, Greece, Spain, Italy and Portugal have achieved just this. This guarantee is worth up to 40% of capital for some banks but what is it worth if from a sovereign like Greece close to default? Stricter Governments like the UK are doing the opposite and threatening to curtail a bank’s ability to recover these assets.

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The FT reported this week on a life insurance contract written by the French insurer L’Abeille Vie back in 1987. Known as a “Fixed Price Arbitrage Life Insurance Contract”, the product was sold to wealthy individuals and offered them the special flexibility to switch at any time between different investment funds at the listed fund price, which back in 1987 was set each Friday. The catch was that a smart (or not even so smart) investor could watch the markets go up or down during the week and would have a whole week to switch in and out of the funds at the previous Friday’s trading price, thereby using hindsight to lock in profits.

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EU’s Bank Resolution and Recovery Directive (BRRD), due to be implemented in 2016, will most certainly adversely impact the credit standing of senior, as well as subordinated bondholders.

The treatment of large creditors in the Cypriot banks provided the first glimpse into what can happen to bond holders when a bank gets into difficulty and the government can’t afford to, or chooses not to, support the bank.

Austria’s adoption of the BRRD, a year ahead of schedule, demonstrates how such rules will work in practice.

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Regulators everywhere would do well to follow the Swiss Financial Market Supervisory Authority (Finma) in making public the minimum capital requirements for its banks based on the risk profile of the bank.

Last year Finma announced the UBS minimum capital targets at 19.2% of risk-weighted assets and an unweighted leverage ratio of 4.6%. For Credit Suisse it was set at 16.7% and 4% respectively.

The targets are substantially more demanding than those set by Basel III rules but it is an understandable position considering that the total assets of these two banks was 4xs GDP at the peak of the crisis. The banks have until 2019 to comply.

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