Tag Archives: Basel III

Major Banks Still Hide $Trillions In The Shadows

After the so-called Wall Street reform and the new Basel II rules has been approved, one might think that we have some kind of framework in place that’ll give us more transparency into the global financial activity, and hopefully a possibility to put the brakes on if any of the major banks should try to run wild again. But that’s certainly not the case. A few major US and European banks still keep about USD 25 trillion – of their total interbank market of USD 55 trillion – in the shadow banking system – with no oversight, no rules and no control.

“The first change that is required is what I have called a true “quantum leap” in the rules that regulate how countries make their national economic policies.”

Jean-Claude Trichet

Map of the most central nodes in the web of financial connections.

The shadow banking system or the shadow financial system consists of non-depository banks and other financial entities – investment banks, hedge funds, and money market funds – that grew dramatically in size after the year 2000 is still playing a critical role in lending between banks and  businesses. It is also a key element in explaining the financial crisis. But little has changed  over the last couple of years.

Shadow banking institutions are typically intermediaries between investors and borrowers. For example, an institutional investor like a pension fund may be willing to lend money, while a corporation may be searching for funds to borrow.

The shadow banking institution will channel funds from the investors to the corporation, profiting either from fees or from the difference in interest rates between what it pays the investors and what it receives from the borrower.

Many shadow-bank-like institutions and vehicles emerged in both the American and the European markets between 2000 and 2008, and have come to play an important role in providing credit across the global financial system.

In June 2008, US Treasury Secretary Timothy Geithner, then President and CEO of the NY Federal Reserve Bank, described the growing importance of the shadow banking system, saying:

“In early 2007, asset-backed commercial paper conduits, in structured investment vehicles, in auction-rate preferred securities, tender option bonds and variable rate demand notes, had a combined asset size of roughly $2.2 trillion. Assets financed overnight in triparty repo grew to $2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the then five major investment banks totaled $4 trillion. In comparison, the total assets of the top five bank holding companies in the United States at that point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion.”

In other words, lending through the shadow banking system seemed to exceed lending via the traditional banking system based on outstanding balances.

The equivalent of a bank run occurred within the shadow banking system during 2007 – 2008, when investors stopped providing funds to (or through) many entities in the system. Disruption in the shadow banking system is a key component of the ongoing financial crisis that started with the  US subprime mortgage crisis.

But in spite of all the new regulations, both legislated and proposed, the shadow banking market seems to keep on growing.

According to the latest estimates from the IMF (illustrated above) the shadow interbank market of the major US and European banks is estimated to about USD 25 trillion, compared to the “official” banking system with an estimated value of USD 30 trillion.

I assume there’s no (or little) data on the Chinese shadow banking market. And if you take all banks in the world into account, you’ll end up with a global financial shadow system of stunningly USD 450 trillion!

Estimated notional value of the global shadow banking system.

Now – compare this to the total value of the global economy.
Or – to the total size of the US economy.

(NOTE: This is the notional value rather than market value, but in uncertain times market values and notional values can converge.)


In short, it’s the massive pile of derivatives accumulated over the past decades.

It’s also tightly coupled and extremely complex, and worse, not fully understood.

It isn’t regulated, nor is it liquid enough to price, which is why global banks are still able to “act” like they are solvent.

Lloyd Blankfein, Kenneth Chenault, Kenneth D. Lewis, Edward Yingling.

You can also view the shadow banking system is as a financial amplification system.
A byproduct of its operation is that it can take small financial events and convert them into financial nuclear weapons that explode with a spectacular display and devastating effect.
I would not be surprised if we were to see more financial nuclear explosions as the shadow banking system may amplify an increasing number of small and unexpected events into a full-blown disasters.

Trichet’s Desperate Call

“The first change that is required is what I have called a true “quantum leap” in the rules that regulate how countries make their national economic policies. Countries need clear rules and procedures to guide policy-making and sanctions if they stray from a sustainable path,” Jean-Claude Trichet said in a speech on February 11.

Trichet pointed out that this means a strengthening of the European Stability and Growth Pact, (the framework first negotiated by the German finance minister Theo Waigel to prevent countries accumulating excessive public debts and deficits).

“The period between 1999 and 2008 was generally acknowledged as a period of economic fair weather. Yet in this period, hardly any euro area country put their fiscal house in order, attaining what might be called a safe budgetary position. What is more, governments decided to weaken the Pact in 2004 and 2005. This initiative was led by the euro area’s largest economies.”

“The ECB voiced its grave concerns at the time. I now see that many acknowledge that the weakening of the Pact was a serious misjudgment.”

“But the crisis has given us an opportunity. It has made plain the flaws in the Pact that allowed countries’ fiscal policies to become a problem, not just for themselves, but for everyone else within the monetary union. We now have an obligation to fix the flaws.”

First and foremost, this means creating stronger and more binding rules for fiscal policy, backed up by reinforced sanctions or mechanisms to ensure compliance with the rules, Trichet said.

Second, a new framework is needed to monitor competitiveness and to ensure that measures are taken to control them.

“We need to put in place binding rules that guide policies towards sustainable and balanced growth. Such a reform package is currently before the European Parliament. The ECB very much counts on the Parliament to call for very clear and strong governance rules, including automatically in triggering procedures and sanctions, which will be to the long-term benefit of Europe’s citizens. In a union with a single monetary policy and 17 different fiscal and economic policies, a “quantum leap” in economic governance is necessary to ensure that the degree of economic union is fully commensurate to the already achieved monetary union.”

(Here’s a transcript of the speech.)

Exactly How Serious?

“Grave concerns,” a “serious misjudgment,”  and need for a “quantum leap” in surveillance and regulation of the banking systemsounds pretty serious to me….

But finding out exactly how serious, is not an easy task.

However, the International Monetary Fund, IMF, have done some research on the topic. Recent published documents and working papers contains some statements, calculations and illustrations that gives some clarity of the problem.

In a working paper on cross-border capital flows from November 2010, the IMF researchers write:

“Thus, with international asset positions now dwarfing output, global portfolio allocations and reallocations have profound effects on the world economy, as demonstrated by recent boom-bust episodes of both global reach  and regional significance (in Asia, Latin America, and Central and Eastern Europe). Such cycles and reversals in cross-border capital flows should not be surprising, given that these flows—more so than domestic ones—imply crossing informational barriers, currency and macroeconomic risks, and regulatory regimes.”

“In contrast to trade in goods and services, there are no widely accepted “rules of the game” for international capital flows—this despite being the principal conduit for the transmission of global shocks.”

“Cross-border capital flows take place without global “rules of the game.” At the Fund [IMF], and in contrast to the obligation to liberalize payments and transfers for current international transactions, the Articles of Agreement explicitly grant members the right to “exercise such controls as are necessary to regulate international capital movements.” Since the failure to amend this provision of the Articles in 1997, the Fund’s work in this area has focused on analytical and conceptual issues, with policy advice not always offered consistently.”

While the consensus amongst professional economist seems to be that the cross-border activity mostly have positive effects on economic growth and financial stability, there is a few studies that points at the following:

  • There is no consensus on the appropriate speed of liberalization. Overly hasty loosening appears to have contributed to financial instability in a number of cases. While gradualism allows agents to adjust, interest groups may use delays to try to frustrate reform.
  • Weak regulation, especially of banks, is associated with financial crises following liberalization and suggests a more measured pace of liberalization, with regulatory reform running in parallel. Specific risk exposures of financial institutions should also be considered.
  • Weaknesses in fiscal or external conditions, or questions on debt sustainability, could result in premature capital account liberalization resulting in a rapid build-up in imbalances or an increase in vulnerability to large reversals in capital flows.

At a systemic level, the size and nature of cross-border financial liabilities between major financial centers implied that unprecedented international coordination is required to mobilize resources sufficient enough to stem the impact of the liquidity shock.

“Given that usage of the US Federal Reserve swap lines rose to US$600 billion during the crisis, it is pertinent to ask how future crises might be tackled should capital flows, and the attendant balance sheet exposures, resume their former growth trends,” the IMF researchers writes.

They also give a few hints on the current trends:

“Strong, structural, economic reasons underpin much cross-border investment: ageing populations in advanced economies, sustained differential in growth potential between emerging markets and advanced economies, steadily improving access to information and declining home bias in investment all suggest capital flows will keep increasing, albeit not necessarily in a steady fashion.”

“The global nature of capital flow cycles suggests that cross-border flows may be driven by common factors such as global liquidity conditions or overall increases in risk appetite.”

“Financial institutions will typically not consider the systemic vulnerabilities their actions engender, and single-country regulation can simply push financial activity elsewhere, without reducing systemic risk. Within economic cycles, banks may generate an externality by taking on too much risk as asset prices rise and the economy expands, without taking into account the consequences to the broader economy when the cycle turns down. This implies small shifts in assets within the institution can generate large capital flows for the debtor countries, and that neither the financial institution nor their home regulators will attach much weight to risks taken in these economies.”

Liberalization, maintenance, or re-imposition of capital controls has responded to domestic policy priorities, and has had often far-reaching consequences for domestic stability.

These policies have also had implications for partners, peer countries and, collectively, the IMS as a whole. Over the past decades, there has been a trend toward capital account liberalization.

Still out of control.

“This trend has declined in recent years, with emerging markets tightening controls on inflows at the margin, although this has not yet made an appreciable difference overall. More generally, for many emerging markets the process of integration with international capital markets has been “stop and go”, with periods of liberalization and growing capital inflows punctuated by reversals, and a less linear approach to liberalization, with some reversals in policy and a more frequent use of capital controls or prudential policies with a similar ultimate effect. The liberalization process has also varied across types of financial instruments, with a larger share of countries maintaining controls on debt creating capital inflows.”

And this is where the money seems to be heading:

Trends in capital flows.

The common roots and potential solutions for risks associated with capital flows arise in the context of an absence of any universal frameworks for addressing them, according to IMF.

In contrast to trade and related payments, for example, there is no universal framework that governs or otherwise oversees international capital movements. In turn, this might lead to the following:

Prolonged maintenance of controls: Could effectively protect the financial sector from competition, and act as a tool of financial repression. Long-run efficiency costs could be high. This idea lies behind the intellectual and policy trend toward liberalization.

Poorly sequenced or “too rapid” liberalization: Financial stability can be compromised by rapid liberalization in contexts of weak supervision or regulation, or unbalanced macroeconomic conditions. Some examples of crises where liberalization and its consequences played a role could include Chile in the early 1980’s and the Nordic crisis of the early 1990’s. Liberalization in accordance with EU accession requirements contributed to several emerging economies in Europe experiencing strong inflows and subsequent reversals in recent years.

Crisis controls: Once such a crisis arrives, controls on capital outflows may be necessary in circumstances where the potential level of outflows exceeds both the member’s adjustment capacity
and the financing available from the official sector.

Externalities from controls: To the extent capital flows to emerging markets are determined by “push factors”, their overall magnitude may be relatively invariant to conditions in individual markets. Imposition of capital controls may simply displace flows to other economies with similar attributes. Policymakers have raised this concern in recent weeks, though it may be difficult to show empirically.

How much is $10 trillion?

Imagine a pile of $100 bills. (US banknotes are about 1/10 millimetres thick):

$10,000,000,000,000 / 100 = 100 billion x $100 banknotes
/10 = 10 billion millimetres
/1000 = 10 million metres
/1000 = 10,000 km (+/- 6,200 miles)

Can you imagine a pile of $100 bills 6.200 miles high – or, if laid flat – stretching all the way from Los Angeles across the USA, over the Atlantic, through Europe, and on to 100 miles past Moscow?

(And 450 trillion?!…)

Mama Mia!

Blogger Templates

IMF: World Economic Outlook Update. January 25. 2011.

Deutsche Bundesbank – Financial Stability Review 2010

Gertrude Tumpel-Gugerell, Member of the Executive Board of the European Central Bank, “The euro area’s economic outlook.” 11232010.

New Journal of Physics. “Worldwide spreading of economic crisis”. 11262010.

President of Bundesbank, Axel A Weber: “Global imbalances – causes and challenges” October 2010.

Economist Intelligence Unit. 2011 Forecast: The Euro Zone Breaks Up

Economist Intelligence Unit. 2011 Forecast: New Asset Bubbles Burst, Creating Renewed Financial Turbulence

BIS Working Papers. “Banking crises and the international monetary system in the Great Depression and now.”


Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics

At The End of Another Decade

New Years Eve 2010 (around midnight): It’s not only another year, it’s also the beginning of a new decade. Looking back at the past 10 years, the stage is set for a mind-blowing decade of technological breakthroughs that have the potential to change or lives completely. unfortunately, we’re probably also in for a long period of financial instability and high levels of unemployment.

“It is possible that we are facing one of the most important decades in a very long time.”


I remember New Years eve of 2000; dot-com-mania, emerging markets,Y2K. However, I also remember 1990; deregulation, digital revolution and another collapse in our financial system. I think I’ve detected two major screw-ups over the last two decades.

I covered the stock market crash in 1987, as one of my first assignments as a financial reporter.

By 1989 economists and politicians had declared the troubles were over, the major  global economies was back on track, producing new jobs.

In my mind, the most memorable from headlines from 1991 was delivered by the Swedish newspaperDagens Industri.”

Like the page 2 editorial:

“Dear God, please cool down our economy.”

And the – now historical – headline from the day the Swedish bank central bank kicked up its key interest rate to 500%:

“Good Night, Sweden”

This was about six months before the crisis hit the Scandinavian banks like a Norwegian heat-seaking Penguin missile, and forced the governments in both Sweden, Denmark and Norway to take public control over the private banks.

They were downsized, sliced up, sold out and merged, and the result was five, six   major banks who orderly divided the Nordic home markets between them, and have so far managed to keep any serious competition out of the region.

All three governments still holds significant ownership in the Nordic banking sector.

The Scandinavian banking crisis was recently held up as an example on how to handle a crisis in the financial industry.

Well, we now have five or six banks in three small countries that have become so “systemically important” that they are “too big to fail,” and will have to be bailed out of “no matter what.”

On a global scale; the creation of financial companies that are of “systemically importance” so they cannot be allowed to default must be (at least one of the) “Biggest Screw-up of the Decade – 1990/2000.”

As for the decade now ending, not keeping up with the developments in the financial industry, allowing it to become an invisible, almost uncontrollable, monster, and not putting a stop to it, is a really heavy regulatory blunder.

In the aftermath of 2001, several financial companies and their executives were accused or convicted of fraud for misusing shareholders’ money, and the U.S. Securities and Exchange Commission fined top investment firms like Citigroup and Merrill Lynch millions of dollars for misleading investors.

Thinking back, it seems like we’ve been moving around in a circle.

Systemically we’re right back where we was in 1992, financially we’re in even deeper trouble.

The new international regulations, as they emerge in the final reports from the Basel Committee (Basel III), doesn’t provide anything that will make any significant and systemically changes.

So, my guess is that we’ll have to struggle with a dysfunctional financial market, debt and “systemically important”banks for still a long time – perhaps another decade.

Sadly, this means that the much debated economic recovery, in form of a helluva lot of new jobs, probably not is going to happen anytime soon.

I’m afraid it could take about another decade to get where we would like to be last year, in terms of labor market conditions.

But I’m also sure the next decade will bring a boom in one particular sector:

On this new years eve, we have more people using Facebook than Google, 60.000 new pieces of malware released on the internet every 24 hours and the banks are setting up high frequency information systems, with super fast connections from major central banks, financial authorities and government offices directly into their high frequency trading machines.

It’s all set for another golden age for computer engineers.

As far as the financial industry goes, it reflects the new market conditions imposed by law makers worldwide.

It’s not that amusing to engineer new financial derivatives, so the focus have shifted to the technical side.

The danger is that the financial markets grows even more complex and unpredictable, tied together in an unofficial, unregulated intranet of dark fiber cables.

And this goes beyond the markets and the economy.

Judging by the rapid pace of development over the last 10 years, the next 10 is definitively not gonna be slower.

With the so-called quantum computers just three to five years away, the computer technology, and our whole way of life, is destined for another evolutionary quantum leap, practically.

It is possible that we are facing one of the most important decades in a very long time.

I wish you all the very best.

Happy New Year!


I’d like to add a special greeting to all new readers/follower in 2010. Thanks for all your encouraging comments.

This summer the econotwis’t blogs (Swapper and Econotwist’s) blasted above  20.000 unique readers per month.

Many of you follow my Twitter, and I’m specially honored to welcome among my followers; the State of Israel, US Homeland Security and the EU Council.

Now that I got your attention; will you please tell the State of Kuwait to stop trying to hack into my computer!?


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Filed under International Econnomic Politics, National Economic Politics, Philosophy, Technology

These Companies Stands To Benefit The Most From BP's Misfortune

Markit Research have made an analysis of which companies they belive will provide the most significant payouts in the absence of BP’s dividend. BP’s dividend suspension in June meant that investors would forego an estimated £7.8 billion in dividends this year. However, there are significant income opportunities from other stocks, according to the report. Markit expects that dividends from just five companies in the FTSE 100 will constitute over 60% of all those paid between now and BP’s next anticipated dividend in February 2011.

“The fact that recent market rumours suggesting BP might bring forward its planned resumption of dividend payments have received so much media attention is emblematic of its importance to investors and highlights the perceived scarcity of major dividend paying stock alternatives.”

Markit Dividend Research

“Markit is forecasting a yield of over 4% on the FTSE 100 over the forthcoming year. So despite the latest CPI annual inflation figures for August remaining stubbornly high at 3.1% and interest rates not looking likely to increase any time soon, real returns from income stocks appear achievable,” the two analysts Thomas Matheson and Arjun Venu writes in the latest edition of Markit Dividend Research.


BP’s dividend suspension in June meant that investors would forego an estimated £7.8 billion in dividends this year. In the absence of this payout, however, there are significant income opportunities from other stocks, according to the report.

“In fact, Markit is forecasting a yield of over 4% on the FTSE 100 over the forthcoming year. So despite the latest CPI annual inflation figures for August remaining stubbornly high at 3.1% and interest rates not looking likely to increase any time soon, real returns from income stocks appear achievable,” Matheson and Venu says:

“Markit expects that dividends from just five companies in the FTSE 100 will constitute over 60% of all those paid between now and BP’s next anticipated dividend in February 2011. This report briefly reviews Markit’s forecasts for each of these companies. For three of these stocks we are expecting dividends to continue to grow, while for the remaining two we expect dividends to remain flat.”

And here they are; the five companies whose shareholders will benefit the most from BP’s misfortune:


* Royal Dutch Shell
“The biggest contribution is expected from Royal Dutch Shell, whose payouts will represent just over a quarter of all dividends paid by FTSE 100 companies between now and February. So far in 2010 Shell has managed to maintain its dividend at the 2009 level of $0.42 per quarter and Markit fully expects this to continue for the rest of the year. In addition to cutting costs, Shell has seen positive trends in oil and gas volumes help to improve earnings and cash flow.

* AstraZeneca Plc
“Markit forecasts AstraZeneca’s 2nd interim payment to grow 6.4% to $1.82, which will constitute 12.7% of all dividends on the index. The healthcare behemoth reported strong first half results and raised its full year earnings forecast for the third consecutive time this year. The company also received backing from the FDA advisory panel for potential “blockbuster” drug Brilinta which has boosted the potential future pipeline and eased worries over numerous upcoming patent expires.”


* Vodafone Plc

“Vodafone has committed to increasing its dividend by 7% per annum over the next two years and its FY11 interim dividend is expected to amount to a payout of almost £1.7 billion. Markit is forecasting an interim dividend of 2.85 pence per share, which will make up 11.2% of all FTSE 100 dividends between now and February.”

* HSBC Plc
“Despite being cut 39% last year, HSBC’s dividend remains substantial. HSBC’s capital position comfortably exceeds the requirements of Basel III and the company has given guidance that it intends to pay a Q3 dividend of $0.08 in line with its existing policy, amounting to 6.8% of dividends on the index.”


* GlaxoSmithKline Plc
“The largest healthcare company in the UK, GlaxoSmithKline has delivered sustained dividend growth throughout the last decade. Markit is forecasting for this to continue with a Q3 dividend of 16.0 pence, up 6.7% from last year. This payment would make up 6.3% of all FTSE 100 dividends. The first half of the year saw sales grow 7% to £14.4 billion and net operating cash flows jump 21% in sterling terms to £4.2 billion, supporting this growth.”

Here’s a short-version of the report.


Filed under International Econnomic Politics, National Economic Politics