Banking regulation meets law of unintended consequences

Thu Jan 16, 2014 12:34am EST
 
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By Laura Noonan

LONDON (Reuters) - Arcane measures designed to make banks safer are pushing trading activity into areas where the banking regulator's writ doesn't run, making conventional markets more risky as volumes dwindle.

Regulators determined to avoid a repeat of the financial crisis that floored investment banks in 2008 and beyond introduced a rule at the beginning of last year that makes banks hold enough capital to cover the worst 12 months in the history of their trading portfolio, on top of a capital provision to cover recent asset volatility.

This "Stressed Value at Risk" (VaR) rule and other measures such as a risk charge that makes it harder for banks to hold lower-rated credit assets have tripled the amount of capital global banks have to hold against their trading books, according to Jouni Aaltonen, director of prudential regulation at European financial industry group AFME.

The knock-on effects are widespread and not always intended.

Bankers say the post-crisis regulation has forced them to trade less, sucking liquidity out of the market and making buying and selling assets more expensive for everyone, from pension funds to corporates.

"The regulators, as well as the banks, don't necessarily have a full grasp of the impact of these types of things yet, and won't have for some time," said one senior executive at a major investment bank, who said there had been "pretty big" repercussions in some markets already.

Mark Denny, head of global markets dealing at Investec Asset Management, said the fall in liquidity had increased the bid/ask spreads for large fixed-income and index trades, making trading more expensive.

"This has resulted, from our perspective, (in our) being very cognizant of the increased trading costs within our business and exploring liquidity pools across asset classes," he added.   Continued...

 
The Canary Wharf financial district is seen in east London February 28, 2013. REUTERS/Stefan Wermuth