STOCK MARKET WATCH -- Tuesday, 29 May 2012

[Demeter]

17. Four Ways to Fix Banks by Sallie Krawcheck (SPAYING AND NEUTERING?)

http://hbr.org/2012/06/four-ways-to-fix-banks/ar/1

It is tempting to view the financial downturn as a closed chapter whose primary causes have been resolved—perhaps not perfectly, but fairly comprehensively—by the Dodd-Frank Act’s reregulation of the financial services industry. But big banks continue to have a governance problem, which poses significant risks not just to them but potentially to the entire economy during the next downturn.

It is well-known that many banks were nearly wiped out in 2008 by a global financial crisis they helped cause. Since then most of them have been nursed back to health, with lots of help from taxpayers and central bankers. Yet despite the reregulation, they remain complex, opaque institutions in the business of taking enormous risks. Figuring out how to oversee them successfully—to keep their risks in check while allowing them to be profitable and economically productive—is a continuing unmet challenge for boards, regulators, and society as a whole.

Upgrading bank boards is one way to take on the challenge. Since the crisis, boards at major banks have revamped their membership and substantially increased their time commitments. This movement could be taken even further: Robert C. Pozen has suggested (“The Case for Professional Boards,” HBR December 2010) that board membership at a big bank should be a full-time job. But even smart, experienced, full-time board members would struggle with the staggering complexity of the biggest banks. Without a way to cut through this complexity to the core issues and drivers, they’d have little hope of steering their institutions in a risk-sensitive fashion.

The main tool with which boards and regulators have managed risk at banks in recent decades is the capital ratio. The logic is that the higher the capital ratio—that is, the more money set aside against potential losses—the lower the risk. This is simple enough in theory but wildly complicated and confusing in practice. It’s not at all clear what the right amount of capital is; in fact, it’s not even clear how capital should be measured. At any given board meeting, bank directors will hear about GAAP capital, capital as measured under the current Basel regime (international standards set by bank regulators), capital as measured under the coming Basel regime, and the bank’s own view of the right amount of capital, often called economic capital. Within these categories are various subcategories, including Tier 1 capital, tangible capital, and total capital. These capital measures often fail to keep up with market events. Also, the calculations can be shaped by banks’ own assessments of risk, regulators’ assessments of banks’ risk models, and ratings from rating agencies—all of which are subject to underlying biases, to put it mildly....

1: Pay Executives with Bonds as Well as Stock

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