Bloomberg Businessweek - USA (2019-12-23)

◼ FINANCE Bloomberg Businessweek December 23, 2019

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someassetsarelessriskyandcanchoosenottofully

countthem.Assetssuchasgovernmentbondsdon’t

countatall,meaningEuropeanbankscanholdpiles

ofGreekandItalianbondsandtreatthemasif they

holdzerorisk.

Although the adjustments the banks make

in-housearesupposedtobereviewedbyregulators,

mistakesstillslipthrough.Earlierthisyear,the

U.K.’sMetroBankadmittedit miscategorizedsome

mortgageloansina waythatundercountedits

assets.Afterit disclosedtheproblem,it hadtoraise

£350million($456million)innewcapital.

Everybodyrisk-adjusts.JPMorganChase& Co.,

thebiggestU.S.bank,saysitscapitalbacksup12%of

itsassetswhenthey’rerisk-adjusted.Theratiodrops

to6%withouttheadjustments.That’sbecausethe

adjustmentsshrinkthebank’s$2.8trillionbalance

sheetto$1.5trillion.Theshrinkingbalancesheet

ismorestrikingatEuropeanbanks,whichhave

broaderleewaytouseinternalformulasforcredit

risk.DeutscheBankAG’s€1.5trillion($1.67tril-

lion)balancesheetbecomes€344billionafterrisk-

weighting.Thathelpsitscapitalratiojumpfrom4%

toa risk-adjusted13%.

●CAPITALRELIEF

Someriskadjustmentssoundreasonable—U.S.

andGermangovernmentbondsreallyaresafe—

butthey’restillmoreartthanscienceandwide-

opentobeinggamed.Forexample,bankscanpay

someonetotaketheirriskawayforthem.“Capital-

relieftrades”haveineffectmovedhundredsofbil-

lionsofdollarsoffbanks’balancesheetsbymaking

it lookasif loansthebankshavemadedon’texist.

Thesetradesessentiallytaketheformofinsurance

policiesguaranteedbycounterpartiesthatinclude

hedgefunds.It’sgoodtohaveinsurance.Theprob-

lemis,ina meltdown,thosecounterpartieswould

needtobeabletomakegoodontheirobligations

forthetradetoholdup.

A 2017dealbyRabobankGroup,thesecond-

biggestDutchlender,movedtheriskofdefault

on€3billionofprivateloanstoa Dutchpension

fund.ThetransactionhelpedRabobankcutitsrisk-

weightedassetsby€1billion,thebanksaidatthe

time,withoutprovidingfurtherdetails.

Ina 2015report,theU.S.Treasury’sOfficeof

FinancialResearchfoundthat 18 largeU.S.banks

hadmade$38billionofcapital-relieftradesthepre-

viousyearthatcouldhaveboosteda bank’scapital

ratiobyasmuchas4 percentagepoints.

Capital-relieftradesareanexampleofshifting

riskfrom banksintotheshadows,tononbank

entities such as hedge funds that don’t get any-

where near the same scrutiny. “As regulation

tightened, some of the risk has shifted to other

parts of the financial system,” says Nicolas Veron, a

senior fellow at the Peterson Institute of Economics

in Washington. But the trades could pose a conta-

gion risk that gets back to banks anyway. A hedge

fund selling insurance often borrows from banks

to finance its investments. If losses were to mount

high enough, the fund might not be able to repay its

lender—or the bank counting on its insurance policy.

● THE ITALIAN JOB

The Milan convictions (which are expected to be

appealed) of former Deutsche Bank, Nomura,

and Monte Paschi bankers were the culmination

of one of the most audacious known episodes

of fake finance. When Paschi, the world’s oldest

bank, started suffering losses toward the end of

2008, its outside investment bankers offered what

seemed to be magic solutions. In the case of the

deal Deutsche Bank pitched, Paschi would enter

into two different trades of derivative contracts.

One would be an instant winner that would extin-

guish current losses, and the other would be a sure

loser—but far in the future.

For the purposes of the yearend reports, share-

holders and regulators would have no idea there

had been massive losses on the initial bet, let alone

that the bill would eventually come due. Paschi had

to restate its financials (and get government bail-

outs) after Bloomberg News uncovered the fakery

in 2013. Deutsche Bank, in addition to reaping mil-

lions in fees, found a way to keep the transaction

off its own balance sheet by having its components

of the deal cancel each other out. Deutsche Bank,

too,endedupadjustingitsaccounting.

The big banks don’t dispute that tougher

regulation—especially higher capital and some min-

imum liquidity requirements—was necessary after

the 2008 crisis. But they argue that the pendu-

lum has swung too far and excessively tight rules

are hampering their ability to provide credit to the

economy. “How much is enough capital?” Morgan

Stanley Chief Executive Officer James Gorman