Resolution Deal Shows ShoreBank Was Savvy to the End

By Robert Barba

Even in failure, ShoreBank adroitly maneuvered the political waters. The $2.16 billion-asset Chicago institution, the nation's first community development bank, was seized by regulators Friday after months of trying to stay afloat. Its deposits and nearly all its assets were sold to Urban Partnership Bank in Chicago, a new entity backed by the same investment fund that had been working to rescue ShoreBank. At Urban Partnership's helm is David J. Vitale, who was brought in as ShoreBank's chief executive in March to save the ailing institution. The Federal Deposit Insurance Corp. said the group's bid was the only one it received for ShoreBank. The structure allowed the group to sidestep a politically sensitive subject: open-bank assistance. Though used during the savings and loan debacle, it has not been in recent years. A regulatory overhaul in the 1990s made it all but impossible to attempt such assistance except in certain cases. The fact that ShoreBank's owners were wiped out puts the resolution in the category of failure instead of open-bank assistance. "Open-bank assistance throws good money after bad. That is not the case here. It's new money," said Karen Shaw Petrou, managing partner at Federal Financial Analytics Inc. "In a [purchase and assumption] the old shareholders and the old debtholders and everybody else are toast. They aren't toast in an open-bank deal."

Basel Committee Says All Capital Should Be Loss-Absorbing

By Donna Borak

Taxpayers shouldn't be the only ones paying the price for bank bailouts, international regulators said Thursday. The Basel Committee on Banking Supervision said investors should also help in absorbing losses in the event of future public-sector assistance because of excessive risk-taking. "During the recent financial crisis a number of distressed banks were rescued by the public sector injecting funds in the form of common equity and other forms of Tier 1 capital," the committee wrote. "This had the effect of supporting not only depositors but also the investors in regulatory capital instruments." The Basel panel issued a consultative paper arguing that all regulatory capital instruments should be capable of absorbing losses — either written off or converted to common shares — in the event a bank is unable to find support in the private market. International regulators are trying to avoid a repeat of what occurred during the latest financial crisis, when Tier 2 capital instruments, primarily subordinated debt, did not absorb losses. "In order for instruments to be treated as regulatory capital, the committee considers it a precondition that such instruments are capable of bearing a loss," the Basel panel wrote. Still, some analysts viewed the committee's proposal as evidence of a continued dispute among regulators over how to define capital. "The consultative paper goes beyond talk of contingent capital to address both Tier 1 and Tier 2 capital, mandating that all instruments have demonstrable loss-absorption capacity," said Karen Shaw Petrou, managing partner of Federal Financial Analytics Inc. "This is in conflict with other proposals to permit certain intangible capital — e.g., deferred tax assets — to count, making clear that the overall issue of what's capital remains a significant point of contention."

Viewpoint: Basel III + Dodd-Frank = Little Leeway on Capital

By Karen Shaw Petrou

For years, the Basel Committee's capital rules went virtually unnoticed despite the profound impact regulatory capital has on bank profitability, competitiveness and line-of-business decisions. Basel III isn't, though, following I and II into obscurity, with recent editorials in The New York Times and The Washington Post focusing on the new capital and liquidity standards.

Attention has largely centered on claims that banks have so watered down Basel III that a new, capital-driven crisis looms. To be sure, the late-July Basel III agreement took out a few teeth from the formidable array of fangs Basel bared in the December consultative papers. But, the new standards will still bite hard into bank strategic assumptions, with the U.S. ones mandated by the Dodd-Frank Act sure to tear even bigger holes into business.

To assess this strategic impact, it's vital first to have a clear sense of what Basel III will do and how that does or doesn't jibe with Section 171 (often called the Collins amendment) and other capital-related provisions in the Dodd-Frank Act. Then, one needs to know what capital requirements do and don't do to bank strategic decisions. From this, winners and losers emerge.

One reason critics have been harsh about Basel III is that each compares the new regime to his or her own idea of capital perfection. As with judgments about truth and beauty, this is a dangerous path, as each of us also has our own idea of the ideal, most often unattainable by mortal effort. Thus, a real-world evaluation of Basel III needs to remember that it's the product of complex, global negotiations.

That anything emerges at all is an achievement. That what came out is remarkably close to what most analysts call reasonable, even if not ideal, is then striking. Finally, that this time around, the Basel negotiators didn't take a full decade to deliberate is notable (although here we won't spread much praise because the reason for unusual alacrity was the global financial crisis in part wrought by all the years of Basel indecision that went before).

But, so far, not so bad. Then, too, a real-world judgment about Basel III needs to compare it to Basel I and II. If not perfection, Basel III is at least a darn sight better than what went before — a point, by the way, on which even the most perfection-minded Basel critics agree. If Basel III is better, even if not the best, to send it back to the drawing board now will either leave Basel II in place or, worse still, create a vacuum of continuing uncertainty over global capital rules that will further delay recovery.

Basel critics also forget the tough standards finalized in 2009 set to go into effect next year. These address resecuritization — one source of the crisis — and the trading book (that is, market-risk-related capital). Much here is highly technical, but the bottom line isn't. The trading-book rules will, for example, boost capital in this part of the business by as much as 600-700%, contributing to the global rewrite of bank trading activities inside and outside the U.S. Here, of course, the Volcker Rule will add still further impetus to a strategic rewrite of bank capital-market activity.

And, anything Basel can do, the U.S. will do tougher. That's the mandate Congress has now given the U.S. banking agencies. And, Congress told the banking agencies not only to do Basel tougher, but also to do it faster.

The Dodd-Frank Act sets out a two-tier capital system: a "generally applicable" one for most banks and a still more stringent one for systemically vital institutions. The current U.S. capital standards are the floor for the new framework, meaning that anywhere Basel III gives a little, the U.S. will have to take it back.

Advocates of this approach pushed for it to cement standards like the U.S. leverage rule more or less as is. But, this takes no account of everything else under consideration in Basel III and mandated elsewhere on capital in Dodd-Frank. Thus, U.S. capital rules will pile one charge atop another — that's what the law says — instead of calibrating regulatory capital to better reflect real risk and, even more important, reward those who don't take it.

But, like it or not — and I don't — that's the law. In fact, Congress this fall will push to ensure its tough tone is taken to heart. Worried by all the press suggesting big banks won in Basel III, hearings are on tap to chastise regulators wherever any give was granted.

Finally, to why capital matters so much. Suggestions that regulatory capital doesn't count for much are often based on academic models that have considerable value in their own context but don't fit well with bottom-line business judgment. Models notwithstanding, strategic decisions are — or at least should be — based on two capital-driven factors: risk-adjusted return on capital, which drives line-of-business capital allocation, and return on equity, which tells investors what they can expect to receive in return for their tangible common equity.

Change the C in RAROC and the E in ROE and these equations change a lot. Thus, when regulatory capital adds a kicker to the C in RAROC, banks reallocate capital or take more risk to make the numbers work to their satisfaction. It was precisely this balancing act that took banking off the rails before the crisis. Capital didn't capture risk well, so banks drove risk up to make RAROC rock. Bank regulators now will try to capture risk through new prudential rules that come in tandem with risk-based capital ones, but how well this works will dictate where regulatory-arbitrage opportunities remain.

While RAROC drives internal line-of-business capital allocation, ROE tells investors whom to love. Thus, differences in regulatory capital between U.S. and non-U.S. banks and between banks and nonbanks at home and abroad will remain profound strategic drivers in the postcrisis marketplace. As before the crisis, regulators can control capital standards only for those under their sway, with "shadow" banks largely outside the capital sphere unless they trigger systemic regulation under the Dodd-Frank Act. This leaves the "shadow" banking system much as it was before the crisis, even though banks are about to come under tough new rules that will be even more formidable in the U.S.

Unlike Last Effort, New Basel Process Zips Along

By Donna Borak

While the Basel II process dragged on for years, international and domestic regulators appear intent on delivering a new set of capital and liquidity standards on time by yearend. Although some were skeptical when the Group of 20 industrialized nations pledged to agree to higher standards by their upcoming meeting in November, the Basel Committee on Banking Supervision has already made significant progress toward that goal. It released revisions last month to its December 2009 proposal, and is set to unveil later in August its economic impact assessment on new capital rules. The panel is expected to put forth finalized calibration and phase-in agreements by its next meeting in September. Among the biggest changes in the plan was an international agreement that a global ratio should be enacted. The committee proposed a minimum leverage ratio of 3% for a trial period from 2013 until 2017 to assess how well it works. A final cap could be effective as early as 2018. Such a level is less stringent than U.S. rules. Karen Shaw Petrou, a partner at Federal Financial Analytics Inc., warned that such a prolonged transition period could inevitably make the proposal "irrelevant." "When a final rule has a 2018 deadline, quarter-by-quarter planners put it aside for another day," Shaw Petrou said. "Even longer-term planners … discount it because so delayed a deadline seeds hope that a rule will be reversed."

Banks find themselves in a tough spot

KAI RYSSDAL: I guess it took Wall Street a day or so to fully absorb the mean things the Fed said yesterday about the economy because "sell" was the word of the day in stocks. But back to what the Fed did say yesterday: It's not going to add more money to the economy. It is, though, going to reinvest the cash it put in during the financial crisis toward buying government debt and helping push interest rates lower. That money is supposed to help banks shore up their balance sheets and at at the same time, somehow encourage them to lend more. Marketplace's Alisa Roth reports. ALISA ROTH: Bankers say they're in a tough spot. They're being told to hold lots of money in their reserves in case things go south. They're also being told to lend more money to encourage the economy. But they're also supposed to be very careful about whom they lend to. KAREN PETROU: We, as your regulators, really encourage you to go out and make loans. As long as they're prudent. Karen Petrou is a banking analyst at Federal Financial Analytics. She says the problem is with that word -- prudent. For years, the banks took on more risk. Then the financial crisis came. And now, banks don't know what prudent is supposed to mean. Petrou says the regulators' guidance isn't helping. PETROU: And here are some things that make them prudent. But then there are some other things that might not. At which point, the banks look at those statements and scratch their heads and say, "OK, now what do I know?" What they say they know is that there aren't any borrowers. That potential borrowers -- both regular people and companies -- are just too anxious to take on more debt. And that you can't force people to borrow. The housing market is a good example. Mortgage rates are ridiculously low. There have been all kinds of tax credits and buyer incentives, but nobody's taking out loans to buy houses.

To listen to the full story click here: http://marketplace.publicradio.org/display/web/2010/08/11/pm-banks-find-themselves-in-a-tough-spot/.