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Bankers Are Playing With Fire, Once Again

Elisa Martinuzzi

(Bloomberg Opinion) -- As 2019 draws to a close, there’s more than a whiff of banking deregulation in the air. The U.S. has relaxed its lender stress tests and made it easier again for Wall Street to trade using its own funds. In Europe, capital requirements are being softened.

The reining in of bank risk after the financial crisis is giving way to a loosening of the rules just as the desperation for yield makes banks more willing to gamble. This seems imprudent: Although banks are safer than they were before Lehman Brothers imploded, critical weaknesses remain.

Sheila Bair was chair of the U.S. Federal Deposit Insurance Corp. — the body that preserves confidence in the American banking system — from 2006 through 2011, and she’s a current board member at Industrial & Commercial Bank of China Ltd. As such, she has a unique insight into how far lenders have changed. I interviewed her in Washington DC recently for a Bloomberg Storylines episode about Italy’s Banca Monte dei Paschi di Siena SpA, “How a $450 Million Loss Was Made to Disappear.”

In November, 13 bankers from Paschi, Deutsche Bank AG and Nomura Holdings Inc. were convicted for helping the Italian lender hide losses in 2008. It may be an old case but it still serves as a cautionary tale of how banks can massage their numbers.

Crucially, as I discussed at length with Bair, banks’ accounts are still impenetrable and reforms have done little to improve transparency. Complex transactions can obfuscate lenders’ true financial health, while more detailed rules have made regulatory reporting and external scrutiny even harder.

Here’s an edited transcript of our conversation:

ELISA MARTINUZZI: Before Monte Paschi, Lehman Brothers had also used an accounting trick, “Repo 105,” to make its books look stronger. What have we learned from Lehman?

SHEILA BAIR: The continued availability of accounting tricks to dress up your regulatory ratios and your public disclosures, I think. And it’s still going on.

EM: How far has post-crisis regulation curtailed the banks’ capacity to work around the requirements?

SB: Whether it’s [tackling the] accounting gimmicks people used to game their regulatory ratios or just more fundamentally how much capital and liquidity there is in this system, we’ve made them a little better. But we really haven’t made any kind of fundamental reforms.

EM: How concerned should taxpayers be?

SB: As a citizen worried about the stability of the economy, which relies on a stable financial system, I think people should still be concerned. There’s this kind of assumption that it’s yesterday’s news. And I think that’s probably ill-advised because I think there’s still some real fragility in the system.

There’s too much complexity around the financial instruments that we tolerate on regulated banks, the exposures that they take. And frankly, culture too. I mean, do bank managers of integrity use derivatives to dress up their balance sheet or try to hide a risk and losses that they have? No, I don’t think good managers would do that. But there probably is still a culture problem too in the financial services industry that management will entertain strategies like that when they shouldn’t.

EM: How has transparency around disclosures improved?

SB: If anything, we’ve made it harder because it seems so many of the rules, especially around capital and liquidity are so complex to the extent investors or others — analysts, journalists — want to determine how good those rules are and how effectively banks are complying with those rules. I think the complexity really hinders that kind of outside discipline. It’s kind of an inside game now with the banks and their supervisors.

EM: Where do you see systemic risk building up today? Is it away from the banking industry?

SB: Nothing’s really outside the banking sector, because we [saw] during the subprime crisis too that all of these toxic mortgages were being passed on broadly to investors.

EM: Are memories of the financial crisis fading?

SB: It really distresses me, because having lived through that and thinking that we had learned our lesson, to see what’s going on now [simplifying and weakening the post-crisis rules] is just wrongheaded. 

The debate we should be having is what’s going to happen in the next year or two if the U.S. economy, or more likely the global economy, slides into recession; how well banks are prepared, should they be building a bit more of their capital cushion now?

EM: Are you confident we won’t be seeing another Monte Paschi? 

SB: No, I'm not confident that we won't. I absolutely would say that I'm not confident we won't. No, no, no.

To contact the author of this story: Elisa Martinuzzi at emartinuzzi@bloomberg.net

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.

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