Thursday, December 13, 2012

UBS: we have learned our lesson as $1 billion fine for manipulating Libor approaches

In an interesting interview in Der Spiegel, UBS Chairman Axel Weber explained that the new rules for trading had driven the decision to shrink their investment bank by 10,000 individuals and that UBS had learned its lesson that it needed a risk control system that permits no blemishes.

At the same time, the Wall Street Journal is reporting that UBS is finalizing an agreement with global financial regulators under which it will pay $1 billion for its role in manipulating benchmark interest rates including Libor and Euribor.

I wonder if under Mr. Weber's leadership, UBS is going to be the first global financial institution to voluntarily adopt ultra transparency and disclose on an ongoing basis its current global asset, liability and off-balance sheet exposure details?

There are two reasons for asking this question.

First, ultra transparency is the ultimate risk control system.  Ultra transparency promotes market discipline to control and restrain risk taking as everything the bank does becomes visible before the beginning of the next business day.  If there is a blemish, it is likely that market participants will find it.

Second, ultra transparency eliminates the risk of bankers engaging in activities like the manipulation of benchmark interest rates again.  Instead, UBS can lead the development of new benchmark interest rates based on actual transactions that replace the current manipulated benchmark interest rates.

SPIEGEL: The misconduct was widespread throughout the entire industry when it came to manipulating the LIBOR key interest rate. Was it a case of organized crime? 
Weber: There are 150 different rates in the LIBOR system. There were deep distortions within the system. The truth will only gradually come to light, and many investigations are just getting underway. 
SPIEGEL: What was especially new about the scandal was the fact that there was collusion among different banks. 
Weber: The LIBOR rate is an indicator of the health of each particular bank. And there was apparently an attempt by some to paint themselves in a more favorable light than was actually the case. This may not be organized crime, but in my view the LIBOR scandal poses one of the fundamental risks to the reputation of the entire banking industry. We still have a lot to do to work off this scandal....
Providing ultra transparency would go a long way to restoring the reputation of the entire banking industry.
SPIEGEL: You have now gone from being a watchdog and regulator to one of the regulated. Is the trimming of investment banking business at UBS a logical consequence drawn from your previous role? 
Weber: What helps me the most in reorienting UBS is the fact that, as a regulator, I played a key role in shaping the new basic conditions for banks after the financial crisis. That's why I know that the new rules for trading operations, equity capital and liquidity will fundamentally change investment banking. For complex trading operations, in particular, the capital requirements will be so high in the future that they can no longer be pursued in a profitable way. That's why UBS will no longer engage in certain businesses. 
SPIEGEL: So these businesses aren't worthwhile for UBS or any other investment bank? 
Weber: Each bank will have to decide that on its own. For a while, one can indulge in the illusion that the new rules won't happen that quickly, or perhaps won't happen at all. But anyone who believes that doesn't understand how determined the regulators were and are. I'm not one to fall for that fallacy....
Since the new basic conditions for banks after the financial crisis did not address transparency into their 'black box' balance sheet, Mr. Weber is in a great position to establish ultra transparency as the disclosure standard going forward.
SPIEGEL: Is it possible that customers who want certain services will turn away from UBS, benefiting competitors like Deutsche Bank? 
Weber: Of course it's possible. But it can also go the other way. The especially high capital requirements in Switzerland exist because taxpayers here are not willing to accept the risks that result from the risky trading operations of investment banks. That's why they want an equity capital ratio of 19 percent, which significantly improves the resilience of banks. I don't think taxpayers in other countries are willing to take on the risks that their own banks assume when they take away business from Swiss banks.
Of course, without ultra transparency, bank book capital levels are meaningless.  As the OECD pointed out, more of a meaningless number isn't helpful.

The combination of ultra transparency and a high capital ratio would be meaningful.  With ultra transparency, market participants could independently confirm that all the troubled on and off balance sheet exposures were dealt with.  This restores trust in the accounting construct known as equity.

This is important as equity is the key component of bank capital around which the capital requirements are based.
SPIEGEL: Shareholders are also urging other banks, like Barclays, to make drastic cuts to investment banking. Could UBS become a model for the industry? 
Weber: They're welcome to imitate us. The reaction in the markets, with a significant increase in the share price, shows that we are on the right track. With our strategy, we are fulfilling the new capital requirements much earlier than others, and we'll also be able to start consistently paying dividends again much earlier than others. When it comes to the strength of their finances, the position of other banks -- including German banks -- is like that of the northern German lowlands relative to the Swiss Alps. Someone who wants to keep a large balance sheet total in investment banking will have to climb a long and rocky path to satisfy the capital requirements....
There is an alternative explanation for why there was a significant share price increase from cutting back on investment banking.

Investors bid up the share price because they saw UBS reducing its risk by getting rid of its investment banking related exposures.  After all, without ultra transparency, there is no way for market participants to independently assess the risk of UBS.
SPIEGEL: You mentioned the risk to German taxpayers. Would the Liikanen Commission's plans to separate deposit banking and trading operations in European Union banks reduce these risks? 
Weber: In Switzerland, they have concluded that deposits are sufficiently protected if the capital ratios are high enough. This is a neutral approach that doesn't require intervening into the structure of the banks. However, I believe that a form of the divided banking system will become the norm outside Switzerland, in various ways. This can certainly make sense. 
SPIEGEL: Large banks complain that their investment banking operations would no longer be competitive in a divided banking system. 
Weber: It will certainly become more difficult for investment banks to refinance their operations if they no longer have access to deposits from the private customer division. It should be noted that we decided to cut back investment banking even though there won't be a divided banking system in Switzerland. Other banks have yet to see these additional costs.
Regular readers know that requiring ultra transparency eliminates the need to separate investment and commercial banking.  When market participants can assess all of a bank's exposures, they can exert discipline to restrain risk taking across the organization.

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