In a story picked up by the Globe, Renee Altom wrote a piece for the Richmond Fed titled Why was Canada exempt from the financial crisis?; she concludes that a
So to truly understand a country’s financial landscape, you have to go back — all the way back — to its beginning. Financial regulation in a new world typically starts with one question: Who has the authority to charter banks?
This seemingly small choice sets off a chain reaction, according to Michael Bordo and Angela Redish, Canadian economists at Rutgers University and the University of British Columbia, respectively, and Hugh Rockoff, a monetary expert also at Rutgers. They’ve studied the differences between Canada and the United States in several papers dating back to the 1990s.
They argue that the states here prohibited banks from branching, while Canada did not.
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Many economists have argued that this “unit banking” in the United States made banks more fragile. For one thing, banks were rather undiversified.
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According to the recent study by Calomiris and Haber, set out in their 2014 book Fragile By Design, united factions with an interest in keeping banks small succeeded in shooting down attempts at branching liberalization until the 1980s.
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The U.S. Constitution gave all functions not explicitly handed to the federal government, such as regulatory policy, to the states. Interests needed only to win legislative fights at the local level, which was a far easier task than in today’s relatively more federalized system, Calomiris and Haber contended. Thus, they argued that the origins of a country’s financial stability — or lack thereof — are mainly political. Small farmers opposed branching because it would allow banks to take credit elsewhere after a bad harvest. Small banks wanted protection from competition. And many others opposed any signs of growing power concentrated in any one institution — or bank.
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There have been many proposed explanations for why our financial system proved much less resilient than Canada’s in 2007 and 2008, from insufficient regulation, to lax mortgage lending, to our history of government rescues.The longer lens of history shows, however, that any one explanation for financial instability — and therefore any one regulatory attempt to fix it — may be too simple. Even if unit banking is a relic of the past, it is still with us through its effects on the evolution of the U.S. financial system — just as reforms today will determine the shape and stability of the financial system of the future.
The slowdown in trading hasn’t hurt TD & RBC much:
Heading into the current bank earnings season, the worry was that Canadian investment banks would suffer from the same trading slowdown that hit so many global rivals. RBC was particularly in the spotlight, because it has the biggest trading operation of all the Canadian lenders.
Yet their results came in Thursday, and they were surprisingly good considering what the worst case scenarios looked like.
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For RBC, the strength stems from its capital markets operations beyond Canada’s borders. “The growth is really focused in the U.S., and our [fixed income] Europe business has performed well in the last quarter as well. And I think really it’s just more origination in Europe and also the markets are much improved in Europe,” Mr. McGregor added.TD benefited from origination as well, albeit mostly in the domestic market. Asked about the bank’s strong trading numbers in the first half of fiscal 2014, capital markets head Bob Dorrance said they’re “driven significantly by the origination markets.”
Coincidentally, S&P came out with a report titled Delving Deeper Into Global Trading Banks’ Risks And Rewards: A Study Of Public Disclosures. RBC is one of the top 15 global banks for trading, with a 1.8% market share.
Tougher regulatory requirements, particularly as they pertain to capital, have caused some of the biggest global banks to scale back their trading businesses to ensure that profitability clears their cost of capital. Although this has enabled a few select banks with scalable trading operations to increase their market share, the overall trend has been a decline in sales and trading as a percentage of banks’ total revenues–a development that has reduced some of the market risks related to banks’ trading operations from their 2007-2008 peaks, in our view. That said, we believe trading risks remain significant, and could destabilize banks that don’t manage them properly.
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- We have carried out a study of public disclosures by the 15 rated banks with the largest global trading operations to assess changes in the risk of their trading activities.
- Trading as a percentage of overall revenue has declined for most of these banks over the past five years, and trading risks have subsided from their excessive precrisis levels, largely because of stricter regulation and lower market volumes. However, the risks are still significant, in our view, and could destabilize banks that don’t manage them well.
- We don’t expect to take any imminent rating actions on these banks based on developments in their trading activities, but changes in their risk profiles, over time, could lead to positive or negative rating actions.
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Assessing trading risk at banks can be a difficult endeavor because trading positions, especially derivatives and less-liquid securities, are very complex and opaque. Moreover, the value at risk (VaR) models and other internal models that aim to measure market risks can be inaccurate and inconsistent, particularly in relation to peers. And a significant market disruption may render fair values, which are the basis for many derivatives and securities, unreliable and difficult to measure.Notably, two recent Bank for International Settlements (BIS) trading surveys that analyzed risk-weighted assets for market risk showed substantial discrepancies across banks in measuring VaR and also showed that regulatory capital requirements for market risk vary among global banks. An October 2013 BIS paper (“Fundamental Review of The Trading Book—Second Consultative Document”) outlines, among other things, certain proposals to improve the accuracy and consistency of bank trading risk-weighted assets, in order to make them more commensurate with risk. We believe this is a step toward further consistency across banks, but more clarity is necessary (see “Basel’s Proposed Overhaul Of Capital Requirement Calculations For Banks’ Trading Risk Is Only A Step Toward Greater Consistency,” published Jan. 31, 2014). Although VaR has certain limitations–and thus, in isolation, may provide an incomplete picture of a bank’s trading risk–we still believe it has value when considered with other factors in determining market risk. That said, we do not base our analysis on ratios alone, not least because some can be the result of a multitude of different influences, some positive and some negative, which we detail in Appendix 3.
The BIS document is titled Consultative Document: Fundamental review of the trading book: A revised market risk framework. To my astonishment, it does not mention ageing as a test for whether or not something is legitimately in the trading book, but:
Having reflected on feedback from the first consultative paper, the Committee has developed a revised boundary that retains the link between the regulatory trading book and the set of instruments that banks deem to hold for trading purposes, but seeks to address weaknesses in the boundary by reducing the possibility of arbitrage and by providing more supervisory tools. As such, this boundary is more likely to be aligned with banks’ own risk management practices relative to the valuation-based approach.
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The Committee remains concerned about the risk of arbitrage. To reduce the incentives for arbitrage, the Committee is seeking a less permeable boundary with stricter limits on switching between books and measures to prevent “capital benefit” in instances where switching is permitted. The Committee is also aiming to reduce the materiality of differences in capital requirements against similar types of risk on either side of the boundary. For example, the Committee has decided that the calibration of capital charges against default risk in the trading book will be closely aligned to the banking book treatment, especially for securitisations. The Committee is also investigating the development of Pillar 1 charges for interest rate and credit spread risk in the banking book.
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Main differences between the current and proposed definition of the boundary
Intent-based boundary (current) Revised boundary Requirement for reports to supervisors to make the boundary easier to supervise: N/A Requirement for reports to supervisors to make the boundary easier to supervise: Banks must prepare, evaluate and have available specified reports used by banks in their boundary determination decision, including reports on inventory ageing, daily limits, intraday limits (banks with active intraday trading), market liquidity and any deviations from the presumption lists.
So there will be reports! Lots and lots of lovely reports, requiring the employment of an army of regulators to read and another army of ex-regulators to prepare. Super!
It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 18bp, FixedResets down 5bp and DeemedRetractibles off 1bp. Volatility was average. Volume was below average.
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.1510 % | 2,533.1 |
| FixedFloater | 4.52 % | 3.76 % | 32,842 | 17.88 | 1 | -0.2374 % | 3,797.3 |
| Floater | 2.88 % | 2.98 % | 49,779 | 19.72 | 4 | 0.1510 % | 2,735.1 |
| OpRet | 4.37 % | -10.94 % | 32,936 | 0.11 | 2 | -0.0388 % | 2,716.3 |
| SplitShare | 4.81 % | 4.19 % | 58,931 | 4.19 | 5 | -0.0874 % | 3,108.2 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0388 % | 2,483.8 |
| Perpetual-Premium | 5.51 % | -8.89 % | 90,224 | 0.09 | 15 | 0.0052 % | 2,404.5 |
| Perpetual-Discount | 5.28 % | 5.29 % | 106,596 | 14.89 | 21 | 0.1798 % | 2,552.0 |
| FixedReset | 4.53 % | 3.49 % | 191,923 | 4.38 | 76 | -0.0548 % | 2,558.6 |
| Deemed-Retractible | 4.98 % | -3.61 % | 145,983 | 0.09 | 43 | -0.0129 % | 2,529.1 |
| FloatingReset | 2.66 % | 2.36 % | 153,832 | 4.02 | 6 | 0.0198 % | 2,494.6 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| CU.PR.E | Perpetual-Discount | -1.19 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-05-23 Maturity Price : 23.64 Evaluated at bid price : 24.01 Bid-YTW : 5.10 % |
| PWF.PR.O | Perpetual-Premium | -1.07 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2018-10-31 Maturity Price : 25.00 Evaluated at bid price : 25.83 Bid-YTW : 5.08 % |
| BAM.PR.X | FixedReset | -1.05 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-05-23 Maturity Price : 22.14 Evaluated at bid price : 22.56 Bid-YTW : 3.97 % |
| PWF.PR.L | Perpetual-Discount | 1.53 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-05-23 Maturity Price : 24.27 Evaluated at bid price : 24.57 Bid-YTW : 5.23 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| ENB.PF.C | FixedReset | 293,263 | Recent new issue. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-05-23 Maturity Price : 23.12 Evaluated at bid price : 25.02 Bid-YTW : 4.15 % |
| BMO.PR.S | FixedReset | 174,289 | Recent new issue. YTW SCENARIO Maturity Type : Call Maturity Date : 2019-05-25 Maturity Price : 25.00 Evaluated at bid price : 25.48 Bid-YTW : 3.66 % |
| GWO.PR.S | Deemed-Retractible | 156,145 | Recent new issue. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 25.28 Bid-YTW : 5.15 % |
| RY.PR.B | Deemed-Retractible | 127,241 | Nesbitt crossed 125,000 at 25.70. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-06-22 Maturity Price : 25.50 Evaluated at bid price : 25.67 Bid-YTW : -3.61 % |
| RY.PR.I | FixedReset | 115,210 | Scotia crossed 100,000 at 25.63. YTW SCENARIO Maturity Type : Call Maturity Date : 2019-02-24 Maturity Price : 25.00 Evaluated at bid price : 25.61 Bid-YTW : 2.97 % |
| MFC.PR.D | FixedReset | 100,707 | Called for redemption. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-07-19 Maturity Price : 25.00 Evaluated at bid price : 24.97 Bid-YTW : 4.28 % |
| There were 25 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| BNA.PR.E | SplitShare | Quote: 25.62 – 26.00 Spot Rate : 0.3800 Average : 0.2472 YTW SCENARIO |
| CU.PR.E | Perpetual-Discount | Quote: 24.01 – 24.45 Spot Rate : 0.4400 Average : 0.3182 YTW SCENARIO |
| PWF.PR.O | Perpetual-Premium | Quote: 25.83 – 26.19 Spot Rate : 0.3600 Average : 0.2525 YTW SCENARIO |
| BNA.PR.C | SplitShare | Quote: 25.15 – 25.40 Spot Rate : 0.2500 Average : 0.1645 YTW SCENARIO |
| CM.PR.G | Perpetual-Premium | Quote: 25.50 – 25.70 Spot Rate : 0.2000 Average : 0.1213 YTW SCENARIO |
| MFC.PR.J | FixedReset | Quote: 25.82 – 26.06 Spot Rate : 0.2400 Average : 0.1632 YTW SCENARIO |