Archive for the ‘Financial Markets/ Finance’ Category

Why financial entities become customer unfriendly as they grow in size…

April 18, 2017

Nice piece by Ms. Uma Shashikant. It discusses how there is trade off between local service and scale economics. As organisations grow in scale, they compromise on local services. This is perhaps more acutely faced in financial industry more than other industries.

Reform bankers culture and not banks…

April 7, 2017

After so much talk about all kinds of proposals to resurrect financial world, scholars are realising we have to focus on bankers’ culture. There is something really weird about the financial world which gives you perks and salaries which cannot be provided by any other sector. Despite the crisis, bankers continue to make monies like never before.

NY Fed has been talking a lot about culture. Interestingly, Hong Kong Mon Auth also released a document about reforming bank culture.

Further, Prof Charles Goodhart in this post says:

The incentive for those in any institution is to justify and extol the virtues of the decisions that they have taken.   Criticisms of current regulatory measures are more likely to come from outsiders, perhaps especially from academics, (with tenure), who can play the fool to the regulatory king.   I offer some thoughts here from that perspective.  I contend that the regulatory failures that led to the crisis and the shortcomings of regulation since are largely derived from a failure to identify the persons responsible for bad decisions.   Banks cannot take decisions, exhibit behaviour, or have feelings – but individuals can.  The solution lies in reforming  the governance set-up  and realigning incentives faced by banks’ management.

Recent regulatory problems have been greatly reinforced by a widespread tendency to apply human characteristics, i.e. to anthropomorphise, to an inanimate institute, in this case a bank.  We tend to talk about Bank X having assumed too much leverage, or having behaved in an improper fashion—rather than management of Bank X did such and such; We say that Bank X got bailed out rather than the creditors and clients of Bank X got bailed out.

The outcome has been a regulatory system primarily based on imposing a structure of regulations on banks, with insufficient concern about the incentives on bankers to adjust to, and to ‘game’, that system.  By the same token there has been insufficient concern for reform of the incentive and control system facing bank managers.  Some reforms of the governance structure for bankers have been introduced in the UK, for example in the guise of claw-back rules and the senior managers’ regime.  But even while the Bank of England has been in the vanguard on this, I believe that much more could, and should, be done in this respect.

….

The root of the problem is the bad behaviour of bankers, not of banks, who are incapable of behaviour, for good or ill.   The regulatory framework should be refocused towards the latter, with a focus on reforming incentives.

You wonder what has taken it so long to understand these basic issues?

 

What has bank capital ever done for us?

April 7, 2017

Òscar Jordà, Björn Richter, Moritz Schularick and Alan Taylor research the issue:

When US SEC Charges Pastor with Defrauding Retirees (Pastor said he was more trustworthy than bankers..)

March 31, 2017

Fascinating story.

US Securities Exchange Commission has recently charged a Pastor for defrauding customers. He using his religious stature pushed people into giving their savings towards his own venture.

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Finance apart from finance is also an art…

March 30, 2017

Matt Levine of Bloomberg View points to a recent plan by a hedge fund manager to work around GM stock. All kinds of jargons/fancywords are used to package the idea:

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In today’s finance, there is return free risk, but no risk free return…

March 27, 2017

Prof JR Varma just nails it in this post. He quotes from John Cochrane’s blog whose notion of risk is way too simplistic even despite recent crises.

He says economists continue to believe in risk free return whereas more accurately it is return free risk:

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US adopts T+2 settlement cycle for Securities Transactions..(India moved to T+2 system 14 years ago)…

March 23, 2017

Clearing and Settlement system (referred as backoffice in corporate lingo)  is perhaps one of the most understated yet highly important activity in financial markets. When two parties trade, one gets securities and other cash. This settlement process takes time. Earlier these settlement systems ran in months than brought down to fortnight and now to a few days. All this has been possible due to technology.

So you trade on a day it is called as T. The time taken to settle is added to T. So T+5 means settlement shall happen on 5th working day after the trade.

US SEC announced that it shall move from T+3 to T+2 settlement:

The Securities and Exchange Commission today adopted an amendment to shorten by one business day the standard settlement cycle for most broker-dealer securities transactions.  Currently, the standard settlement cycle for these transactions is three business days, known as T+3.  The amended rule shortens the settlement cycle to two business days, T+2. 

The amended rule is designed to enhance efficiency, reduce risk, and ensure a coordinated and expeditious transition by market participants to a shortened standard settlement cycle. 

“As technology improves, new products emerge, and trading volumes grow, it is increasingly obvious that the outdated T+3 settlement cycle is no longer serving the best interests of the American people,” said SEC Acting Chairman Michael Piwowar.  “The SEC remains committed to ensuring that U.S. securities regulation is reflective of modern times, and in shortening the settlement cycle by one day we aim to increase efficiency and reduce risk for market participants.”

Broker-dealers will be required to comply with the amended rule beginning on Sept. 5, 2017.

What is interesting is India moved to a T+2 system in 2003!

Following Finance Minister’s announcement on March 13, 2001 that the rolling settlement would be extended to BSE-200 list would be traded only in the compulsory rolling settlement on all the exchanges from July 2, 2001. Further, SEBI mandated rolling settlement for the remaining securities from December 31, 2001. SEBI introduced T+5 rolling settlement in equity market from July 2001. Subsequently shortened the settlement cycle to T+3 from April 1, 2002. After having gained experience of T+3 rolling settlement, it was felt appropriate to further reduce the settlement cycle to T+2 thereby reducing the risk in the market and to protect the interest of investors. As a result, SEBI, as a step towards easy flow of funds and securities, introduced T+2 rolling settlement in Indian equity market from 1st April 2003.

We are unaware of the progress made in equity markets. Our infrastructure and systems have been ahead of most developed countries for a while..

Reforming Culture (in financial services) for the Long Term

March 22, 2017

I just blogged about why importance of preserving local culture and values as SBI merges its associate banks.

So, one just came across this NY Fed chief William Dudley Speech in London on reforming culture in finance. In evening he participates in a panel discussion titled: Worthy of Trust? Law, ethics and culture in banking.

Dudley who was under fire for corporate misgovernance a NY Fed has earlier also made remarks on culture.

In the recent speech he says:

As I have argued before, incentives shape behavior, and behavior drives culture.  If you want a culture that will support your long-term business strategy, you need to align incentives with the behaviors that will sustain your business over the long haul.6

Incentives—compensation and promotion, in particular—are powerful tools for communicating the conduct and culture you desire for your firm.  Of course, the cultures of firms can and should vary.  But, the culture of every bank should share a common theme: stewardship—a word that implies professional care, exercised year after year for the benefit of the firm and its stakeholders.  A commitment to the long term must be at the core of banking.  Incentives within a firm should support that goal, not undermine it.

My emphasis on incentives is not new, but it bears repeating.  Bad incentives were a key contributing factor in the financial crisis.  In the United States, the Financial Crisis Inquiry Commission concluded that “Compensation systems—designed in an environment of cheap money, intense competition, and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences.”7   This theme applied to all levels of banking organizations.  One notable example was mortgage brokers, who were paid based on the volume of loans they generated, not their quality.8

The financial crisis came to a head in the fall of 2008.  Fast forward eight years to the fall of 2016.  Wells Fargo’s chairman and CEO resigned after regulators uncovered what appeared to be widespread fraud in the retail bank.  Compensation, once again, seems to be at the center of a scandal.  Neighborhood bankers were paid based on the volume of new accounts opened, apparently with utter disregard for whether customers wanted them or even knew about them.  And, like mortgage brokers in the early 2000s, it appears that job security depended almost exclusively on meeting targets, regardless of how those targets were met.  There was a serious mismatch between the values Wells Fargo espoused and the incentives that Wells Fargo employed.9  

Investigations into what happened at Wells Fargo are continuing, so I will wait before drawing more definitive conclusions.  For now, though, it is sufficient to note the powerful role—for good or for bad—that incentives can play in an organization.  I understand that making progress on culture is difficult.  But, if you want the next round of metrics to look better than the last, use a powerful lever—use incentives. 

Today’s discussions—here at Mansion House and later at the Bank of England—are evidence that the issue of culture is important to the private and public sectors alike.  We have to keep working on this.  The public sector must continue to shine a spotlight on the issue, and the industry must continue to demonstrate that it is taking responsibility for its culture.  And, culture cannot be a subject that only receives attention because bad conduct has occurred in the recent past. 

I am convinced that a good or ethical culture that is reflected in your firm’s strategy, decision-making processes, and products is also in your economic best interest, for a number of reasons:

  • Good culture means fewer incidents of misconduct, which leads to lower internal monitoring costs.
  • Good culture means that employees speak up so that problems get early attention and tend to stay small.  Smaller problems lead to less reputational harm and damage to franchise value.  And, habits of speaking up lead to better exchanges of ideas—a hallmark of successful organizations.
  • Good culture means greater credibility with prosecutors and regulators—and fewer and lower fines. 
  • Good culture helps to attract and retain good talent.  This creates a virtuous circle of higher performance and greater innovation, and less pressure to cut ethical corners to generate the returns necessary to stay in business. 
  • Good culture builds a strong organizational story that is a source of pride and that can be passed along through generations of employees.  It is also attractive to clients.
  • Good culture helps to rebuild public trust in finance, which could, in turn, lead to a lower burden imposed by regulation over time.  Regulation and compliance are expensive substitutes for good stewardship.

Good culture is, in short, a necessary condition for the long-term success of individual firms.  Therefore, members of the industry must be good stewards and should seek to make progress on reforming culture in the near term. 

Well, there was a time when NY Fed would never discuss such issues. They were seen as soft and not of any importance. NY Fed was more about hard finance and fancy stuff.

 

When dealing with financial services, one’s default attitude should be distrust and suspicion

March 15, 2017

An interesting post by Dhirendra Kumar of Valueresearch. It is nice when people who belong to financial services warn people to be careful while dealing in finance. After all, financial services business is full of tricks and games around other people’s money. It is for no reason that finance was always treated with suspicion for ages and those who dealt in money highly despised. Despite changing attitude of society towards finance , most financial players contineu to complicate things and missell their products.

He says usually the default option for most activities should be open and trusting. But in finance default should be the opposite which is ironical as finance is all about trust:

Those who have a positive attitude towards what life brings them are more likely to be successful and happy. Or at least, that’s a common belief. There’s more. When you meet someone new, it’s better to assume the best about them since most people are honest and sincere. Generally, things will work out better if your default attitude is open and trusting.

Unfortunately, this is not true while choosing and buying financial services. As a rule, you should assume that everyone who is trying to sell any financial service to you is either hiding something or is actively lying. This maybe only 90 or 95 per cent true but it’s better to assume the worst to protect yourself. The only way to make the right choices when you save, invest and insure yourself is to educate yourself independently, and make your decisions yourselves without having to depend at all on what a salesperson is telling you. Decades of interacting with the customers of financial services and observing how these industries work has left me with the strong belief that when it comes to dealing with them, distrust and suspicion should be the default attitude.

Why should this be the case? Why is buying financial services different from buying, say a jacket or a shoe or a car. There are many reasons for this and while some are to do with specific issues with the way business and regulations are conducted in India, there is a much deeper reason that is fundamental to financial services.

This reason is that the input, product and output of a financial service business is all the same stuff–money, and the only way they can earn more is by ensuring you get less of it. Think about that carefully.

Best way out is to educate yourself:

This has a really important implication: for a given type of financial service, and a given competence with which it is run, the only way the provider can make more money is to give you less of it. If the provider wants more of anything, be it profits or salaries for employees, or more dividends for the owners, then that has to come from reducing what you get. If it wants to increase sales by paying more commissions to agents then that too is paid for by reducing your returns. EVERYTHING comes out of your pocket.

Don’t think that is some esoteric, conceptual model of financial services. This is what drives every interaction you have with your bank, insurance company, stockbroker, mutual fund, and those who are trying to sell you their services. And don’t count on regulators to protect you. In general, India’s financial regulators are always well behind the curve in stopping the malpractices that are rife in all these products.

The only way to protect yourself is to educate yourself with information and knowledge that is not tainted by actually being generated by the same people, and to always be suspicious of everyone who is selling a financial product, and have distrust as your default posture. I know it sounds terrible, but that’s the way things are.

Actually it is sad to see such an article from one of the major spokesperson of financial world.

Are we all macroprudentialists?

March 7, 2017

Julien Noizet of Spontaneous Finance is back to blogging after a break. He questions the government/central bank intervention in financial matters.

In his recent post, he asks the question: Are we all macroprudentialists?

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Lessons from Central Bank of Barbados fiasco: Central Bank chief is a goalkeeper?

February 28, 2017

Finally after much deliberations and total chaos, Dr DeLisle Worrell the governor of Central Bank of Barbados got fired. One of the Deputy Gvernors has been named as the new Governor.

Dr Worrell got fired just a day after the Court intervened that he could keep his position:

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Historically some of the truly radical innovations in finance have come from criminal enterprises…

February 27, 2017

Prof JR Varma has a blog post which debates Uberisation of finance. They key idea here is whether innovations in finance can/should be ahead of regulation. Moreover, should regulation kill or allow innovation?

He quotes from a paper by Pollman and Barry in regulatory arbitrage. The business is done under the assumption that law shall be changed in their favor overtime. In finance we are seeing a surge in technology which also relies on regulatory arbitrage. So, how do we think this will pan out?

Prof Varma points firstly current finance players are fairly tech savvy and know the game. Second and more interestingly is this thing that historically most finance innovations come from criminal enterprise itself!

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Is the banking industry undergoing a change or a transformation?

February 17, 2017

A nice speech by Mr Frank Elderson, Executive Director of the Netherlands Bank.

He nicely mixes the consulting/strategy talk with that of central banking:

Now, the banking industry is facing several challenges. Fintech is rising, consumer trust is damaged and Basel 3.5 is on the horizon. Then there is doubt about the future of Europe, growing criticism of globalisation and uncertainty about the geopolitical landscape. Meanwhile, the world is trying to achieve the Sustainable Development Goals and implement the Paris Agreement.  

Banks will have to adapt – perhaps contribute – to this and the question is how. What is an appropriate business model or strategy? And what is the best form for the key functions that banks perform, such as safeguarding money, providing loans, and determining risk and return? Or is there a future in which non-banking entities perform banking functions?

In discussing these questions, perhaps it’s worthwhile to distinguish between change and transformation. To me, change implies an increase or decrease over time of something while its nature remains constant. Money was first metal, then paper and now digital, but it’s still money. And today’s stock exchanges are in essence quite similar to those established centuries ago.

Transformation is different. It implies something essential changes and a new order emerges. A caterpillar transforming into a butterfly. A child transforming into an adult. Philips, as Hans de Jong so eloquently described it, transformed from a consumer tech company into a health tech one. Transformation takes time, vision and the courage to take tough decisions. And it is anything but easy to genuinely transform an organisation’s culture.

Having said that I wonder: is the banking industry changing or transforming? Perhaps both? I am sure this is something we can debate at our tables later on. For now, I would like to stress that transformation is not just an inspiring concept, but also a practical and operational process. People and organisations have a capacity to transform that can be nurtured. In today’s turbulent environment, banks would do well to evaluate this capacity. It could mean the difference between relevance and irrelevance.

Sums up the issue quite neatly indeed.

He then points to some lessons from the central bank on their work on pension funds:

DNB has conducted research into the capacity of pension funds to transform and we found several things I am sure apply to other industries.

For example, we found that leadership is key. Specifically, individual leaders with the capacity to identify changes in the landscape, develop best-case and worst-case scenarios and create a compelling vision. Also leaders who are able to develop a strategy around this vision and then execute it. The leadership team is of importance, too.

There needs to be openness, trust and diversity in terms of personalities and competences. We also found that pension funds need to be appropriately equipped.

They need to be agile, have an up-to-date IT infrastructure, have sufficient budget and task the right people with the transformation process. And pension funds need to have their house in order. For unless everything runs smoothly, the organisation will focus its attention on managing the present rather than designing the future.

Finally, we found that pension funds need to be proactive. If they wait until the environment forces them to change, they are at risk. Instead, they should proactively adapt. Some pension funds began to transition from a defined benefit to a defined contribution system years ago and they are now in a good shape. Those who haven’t, are struggling to adjust to changing realities. So transformation is a process that can be managed. But the process needs to lead to something. Transformation is a means, not an end. So what is or should be the end result of a bank or the whole banking industry transforming?

He says organisations should have a well-defined purpose (vision/mission?) and work towards their purpose. Netherlands central bank purpose is financial stability (as monetary function in hands of ECB):

De Nederlandsche Bank believes in the value of having a purpose and we cherish ours. We are in this world to contribute to the sustainable welfare of the Netherlands by promoting financial stability. Through this, we also contribute to the realisation of the Sustainable Development Goals. This inspires us and guides us in relating to our stakeholders. And it seems we are not alone in this. Last December, the Dutch Banking Association published a report in which it explored how banks can contribute to the Sustainable Development Goals. I wholeheartedly encourage such explorations.

Many issues simplified..

Central Banks are served by club of elite PhD economists and suffers from groupstink…

February 10, 2017

A former Dallas Fed employee has written a stinker of a book accusing Federal Reserve (applies to most central banks) for all kinds of things. The book is titled as: Fed Up:  An Insider’s Take on Why the Federal Reserve is Bad for America.

The WSJ article provides a glimpse:

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Predicting human behaviour is legal, predicting machines is not?

February 9, 2017

Prof JR Varma of IIMA has a food for thought post.

He points to casinos saying they look for whatever possible ways to predict human behaviour and make you gamble more and more (and lose). However, any person who looks to predict these machines and play the game is deemed as illegal. Why?

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How storytelling drives finance and economics…

February 6, 2017

Brendan Markey-Towler who is an Industry Research Fellow at The University of Queensland has a nice piece.

He says whatever the model and its logic, finally it is the story which leads people to invest in markets:

In his recent presidential address to the American Economic Association, Nobel Laureate Bob Shiller drew attention to the importance of narratives in economics and, particularly, in financial markets. This corroborates some recent research by the author and colleagues at the University of Queensland into the psychology of economic behaviour.

When we tell ourselves stories, we link up a number of different events into a coherent whole. In financial markets and across the economy as a whole, these stories not only affect expectations but are expectations. And expectations shape behaviour.

Our research shows that the more simple a story, the more it extends and agrees with preconceptions, the more persuasive it is. A good story becomes embedded in investors’ minds; the story becomes the expectation.

If a narrative embedded in the mind of an investor tells a positive story about, for instance, profitability, they will act on it. A positive story results in good news in the financial markets.

It is a pity that this building of narrative was once a major strength of economists. This is how they captured the imagination at the first place. Now it is all hopelessly lost.

Reviving PIMCO..

January 31, 2017

Nice Story of how Jackie Hunt is trying to revive PIMCO. PIMCO saw a shocking decline post exit of its star Bill Gross. Now the fund is slowly trying to come up once again:

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Betting on Nordic rain pays better than your average Hedge Fund

January 27, 2017

Jesper Starn of Bloomberg has a nice piece showing how Nordic electricity utilities gave better returns than hedge funds last year.

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Hedge-fund managers are buying air strips in New Zealand in case…

January 24, 2017

An interview of Rob Johndon, President of INET.

He says one indicator to look for is the elite anxiety which is rising . As a result, the top elites in US are buying private spaces in New Zealand and private planes to fly there:

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Legislating Instability: Adam Smith, Free Banking, and the Financial Crisis of 1772

January 20, 2017

This is the title of a book by Prof Tyler Goodspeed. A brief of the book is here.

The failure of Ayr Bank in 1772 was a turning point in financial history. It led to change in thinking of Adma Smith who till then favored banking free of government regulation. Thus, this event continues to inspire financial historians who look for different viewpoints to explain the crisis.

Prof Hugh Rockoff reviews the book and sums up:

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