The Beauty of BCBS 239

BCBS 239 is the commonly-referenced name of a publication released in January 2013 by the Basel Committee on Banking Supervision (a committee of the BIS, or Bank for International Settlements). Its full title is "Principles for effective risk data aggregation and risk reporting".

The publication, which is 28 pages long is available here:
http://www.bis.org/publ/bcbs239.pdf

If you work in a large bank and are not familiar with BCBS 239, it may behoove you to read it.  If you work in risk management, data warehousing or compliance, you're probably already familiar with it.   But if you work in the back office, middle office, or a business line and are struggling with the challenge of unavailable, incomplete, or undocumented data, BCBS 239 can be an important tool in getting your requests taken seriously by your institution's executive management, or data management and IT bureaucracy.

Who wrote BCBS 239?
BCBS 239 was written by a committee of representatives from the financial regulators in 13 countries.  That includes the FRB and OCC in the US, the FSA in UK, and the JFSA and BOJ in Japan.  If you work in a large financial institution, you probably already know the influence these groups have over the project portfolio and purse-strings of your bank.

What does BCBS 239 say?
BCBS 239 lays out 14 principles about risk data, summarized in 4 groups, and further subdivided into 89 paragraphs.  There is a summary of the principles in annex 2 of the document.  But I found that some of the most interesting and useful language is in the detail itself.

BCBS 239 is surprisingly direct in saying what many line-level practitioners have been saying and thinking for years: it shouldn't be so damned hard to get the information I need from my bank's systems on a daily basis.  And I should be able to depend on the accuracy and completeness of that information.  Unfortunately, in today's world of split-second searches over billions of websites and self-driving cars, that is not the reality in most large financial institutions.

BCBS spells out principles that should be no-brainers.  But they are often not followed today.  It's good that the authorities have spelled them out, so that they can be used as ammunition by business users who actually need good data to get a job done.

Here are some of my favorite "no-brainers" that I'm glad to see confirmed by the committee:

• "Controls surrounding risk data should be as robust as those applicable to accounting data."(Principle 3 Accuracy and Integrity, paragraph 36a).  
• "Risk data should be reconciled with bank's sources, including accounting data where appropriate, to ensure that the risk data is accurate." (Principle 3 Accuracy and Integrity, paragraph 36c).
• "Supervisors expect banks' data to be materially complete, with any exceptions identified and explained." (Principle 4 Completeness, paragraph 43).

To me this means a bank must allocate and hold accountable actual staff to make sure the data in the data warehouse is correct and reconciled.  Plenty of staff.  Think how many people are dedicated to making sure the accounting data is correct: Comptrollers, Sarbanes-Oxley compliance people, internal auditors, etc.  And the "risk data" is arguably more varied and complex than accounting data.

• "A bank should establish integrated data taxonomies and architecture across the banking group...."  (Principle 2 Data architecture and IT infrastructure, paragraph 33)
• "A bank should develop an inventory and classification of risk data items which includes a reference to the concepts used to elaborate the reports." (Principle 9 Clarity & Usefulness, paragraph 67)

In other words, the data in the warehouse needs to be well-organized and documented--not just a mish-mash of incompatible records from different source systems.

• Principle 6 Adaptability – A bank should be able to generate aggregate risk data to meet a broad range of on-demand, ad hoc risk management reporting requests, including requests during stress/crisis situations, requests due to changing internal needs and requests to meet supervisory queries.
• "A bank should routinely test its ability to produce accurate reports within established timeframes, particularly in a stress/crisis situation." (Principle 10, Frequency, paragraph 70)
• "Some position / exposure information may be needed immediately (intraday)...." (Principle 10, Frequency, paragraph 70)

In other words, it's not acceptable for IT to demand a project and special budget just to produce some reports for the business.  The data must be available and usable in advance.

Conclusion
For years, those of us who work on the ground in financial institutions have heard statements from data practitioners about the strategic importance of data, and read vague statements of policy and principle from our data and IT organizations.  But at the same time the actual data we see is often incomplete, poorly organized, or inaccurate, and the day to day tasks needed to clean up the mess are never prioritized.

BCBS 239 is a clear and straightforward document that tells G-SIBs and other financial institutions to actually use 21st century technology to deliver practical results.  While it may be a challenge to implement at most banks, it is a challenge whose time has come.

Is Wall Street Shrinking?

Articles:
Wall Street Journal, BofA Readies the Knife, by Dan Fitzpatrick
CNN Money, More Layoffs Looming on Wall Street, by Maureen Farrell

The Wall Street Journal reports that Bank of America is planning to cut $5 billion in costs by the end of 2013, including the elimination of about 30,000 jobs.  CNN reports that their major competitors will probably follow suit.

Is Wall Street shrinking?  Well, it depends how you measure it.  If you look at the number of people employed, yes it is.  Those of us who are producers and even consumers of financial products have seen great increases in efficiency over the years--everything from online brokerage, to ATM machines, to exchange traded funds, to decimalization have allowed Wall Street to service investors more cheaply than ever before.  As the below chart shows, the number of people dedicated to finance has barely budged since 1998 (the first year that the Bureau of Economic Analysis makes figures available), and is now trending downward.

To the extent that Wall Street is part of the "overhead" of our economy, and produces no real wealth, that is good news.   (Although this is little consolation if you are a BofA teller who gets laid off).

But look at the green line on the graph.  This is the percentage of GDP that is produced by the financial industry, which has been going nowhere but up for decades. Except for a few down years, GDP has been steadily increasing over those years, so we are seeing finance making up a steadily larger piece of a steadily growing pie, and doing it without employing more people.  In other words, some people are making a lot more money.  And who are these people?  Shareholders?  You wouldn't know it by me!  Tentatively (until someone proves me wrong) I think we are talking about individuals with out-sized compensations: hedge fund managers, traders, C-suite executives, lawyers.

And again, to the extent that financial services produce no real wealth, and are part of the overhead of our economy (which I believe is the case), this is done at an overall cost to our prosperity as a society.  How has this happened?  I guess that a big part of the answer is "financial innovation", which is a fancy word for getting more people to borrow more money at a higher cost than ever before.  For individuals this means things like new types of mortgages, home equity loans, and credit cards.  On the corporate side there are things like securitization, over the counter derivatives, credit default swaps, all generating hidden fees and spreads which over the years have greatly outpaced any efficiency gains coming from automation and downsizing of clerks.

I believe Wall Street needs to shrink more and become more efficient.  But I hope that the next arena for efficiency gains will be fees, spreads and six or seven figure bonuses, not just clerks' salaries.

FHA Sues Banks: Bad Timing?

Articles:
Wall Street Journal, U.S. Sues Big Banks Over Home Mortgages, Nick Timiraos, Robin Sidel, Ruth Simon
The Economist, Fannie Mae and Freddie Mac: Self Harm

The Economist notes that the two U.S. Government Sponsored entities, FNMA (Fannie Mae) and FHLMC (Freddie Mac) which have a mandate to encourage home ownership in the U.S., mainly by guaranteeing mortgages, have received around $140 billion from U.S. taxpayers.

Their regulator, the Federal Housing Finance Authority (FHFA) has said that they are legally required to conserve assets and protect taxpayers from further losses.  In this spirit, apparently, they have filed suit against 17 banks, for failing to adequately disclose the risks of $196 billion in mortgages which they sold to Fannie and Freddie during the housing bubble.

There may be some sense of justice here.  The banks made a lot of money during the boom (and paid out huge bonuses) by loosening credit standards and making all manner of risky loans.  Why should taxpayers have to shoulder losses when the banks are still around to pay out?

But the problem is, it's bad for the economy.  The banks are in bad shape now, especially Bank of America, which recently received $5 billion in capital from Warren Buffett.  The last thing they need now is a huge open-ended liability coming from the federal government.  The Bush and Obama administrations made a conscious decision that the best way forward out of the recession was to keep the banks alive, recapitalize them and prop them up.  Now the Obama administration is kicking them when they're down.   As a result, they can be expected to re-trench and cut back on risky lending, which will slow the economy further.

I'm not sure if the President approved these lawsuits because of populist political considerations, or if it is just an example of the left hand not knowing what the right hand is doing.  But if the goal is to strengthen the economy and create jobs, it sure looks counterproductive to me.

Its easy to criticize the decision to prop up the existing Wall Street system that was made a couple of years ago.  But that was the decision that was made, and we can't have it both ways.  Wall Street can't be the savior and the villain at the same time.

Here is the picture (again from The Economist) that tells 1,000 words:

Buffet Buys a Stake in Bank of America

Story: Yahoo News, Warren Buffet to Invest $5 Billion in Bank of America, Ben Berkowitz and Joe Rauch

One of the big stories of the day was the announcement by Warren Buffet that his company, Berkshire Hathaway would make a $5 billion investment in Bank of America.  Over the last several weeks we have watched shares of BofA go down to levels not seen since the financial crisis, due to its ongoing exposure to liability from bad mortgages from Countrywide Financial, which Bank of America bought in 2008.  There have also been rumors that BofA has large amounts of exposure to European banks.  Other financial institutions have followed BofA down, though to a lesser extent, with Citigroup in particular (which I hold in my portfolio) taking on the appearance of a "BofA lite".  (See below chart from Yahoo Finance: BofA is the blue line; Citi is green).

3 month chart from finance.yahoo.com

The announcement of the deal, which Buffet --now said to be the third richest man in the world with a net worth over $50 billion-- thought up while in the bathtub, caused BofA stocks to jump considerably, along with the other financials.

5 day chart from finance.yahoo.com

As of this writing, the Dow Jones Industrial average has followed the European markets downward, and is now off by about 130 points or just over 1% -- which used to be a lot, but could change in the blink of an eye  in these recent weeks of high volatility.  But the financials are a bright spot, at least today, with BofA up by over 10%, and Citi up by just under 5%.

Details Revealed of $1.2 Trillion in Secret Loans

Articles:
Bloomberg.com, The Fed's Secret Liquidity Lifelines, Bradley Keoun, Phil Kuntz et al, graphic by David Yanofsky

Bloomberg.com, Wall Street Aristocracy Got $1.2 Trillion in Secret Fed Loans, Bradley Keoun and Phil Kuntz

The Atlantic Monthly (April, 2010), Inside Man, Joshua Green
Data: http://www.federalreserve.gov/newsevents/reform_transaction.htm

My favorite part of the Bloomberg report was the beautiful interactive Adobe Flash graphic, by David Yanofsky.  It gives a list of all the banks that participated in the lending program (407 of them!), with the peak lending amount and date.  If you click on an individual bank, you are taken to another graphic which gives you the bank's borrowing over time, as well as their market value, plus some additional description.  It also lets you graph multiple banks together in order to do a comparison.

Click on the image below to take a look.    

from Bloomberg.com -- click for original graphic

Where would we be without the Fed?

Among the Federal Reserve Bank's most important functions is serving as lender of last resort for the U.S. banking system.  In ordinary times this function is used sparingly, through the Discount Window.

New York Fed headquarters, from www.newyorkfed.org

But during the liquidity crisis of 2007-2009, a lot of financial institutions borrowed money from the Fed, under the guise of various lending programs with names like: Term Securities Lending Facility (TSLF), Primary Dealer Credit Facility (PDCF), Commercial Paper Funding Facility (CPFF), Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), etc.

Today, Bloomberg.com released a report giving many details of the lending programs, based on databases released by the Fed under the Dodd-Frank Act, as well as information obtained under the freedom of information act.  Some of this information can be seen on the Fed's website.

The lending reached a peak of $1.2 trillion in December 2008, a number which Bloomberg reporters note was:

• 3 times the size of that year's U.S. budget deficit
• 25 times the previous lending peak reached on September 12, 2001
• More than the total earnings of all federally insured banks from 2001 - 2010
• Enough to fill 539 Olympic-sized swimming pools if denominated in $1 bills (which it certainly was not)

It should be noted that these programs were not exactly bailouts.  All the loans were collateralized (though the quality of the collateral varied) and repaid for the most part.  Still, it gives a sobering picture of the extent to which the Fed, and by extension the U.S. government was propping up the banks at that time.

Why did we do it this way anyway?  I think Joshua Green's April 2010 Atlantic Monthly article gives a pretty good idea of the thinking at the time.  Basically, propping up (and reforming) the existing financial institutions was the cheapest option.  There would have been some justice in letting banks fail, and wiping out the bastards who played fast and loose with our trust and destroyed our economy.  But it would have been even more disruptive of the economy, and probably would have caused deficits to balloon even more than they did.  Basically, both administrations --Bush and Obama-- were taking a conservative, low-cost approach, provocative statements by Republican candidates and Fox News commentators notwithstanding.  But what a shame that they had to leave the same people who caused the mess in charge of Wall Street, and that those people proceeded to fight tooth and nail against any meaningful reform.

It is also interesting to note how much we depend on the Fed even today.  While our elected officials fight endlessly over fiscal matters, generating unprecedented volatility in the stock market, statements from the Fed that rates will remain low for the next two years and bond purchases by the European Central Bank seem to be the only thing that have made the markets feel any confidence lately.

Shocking! Big Global Custody Banks Don't Give Competitive FX Rates

Article: WSJ, Two States Go After Big Bank on Forex, Tom McGinty and Carrick Mollenkamp

An article in today's Wall Street Journal reports that two states --Virginia and Florida-- are suing their pension funds' custodian bank, BNY Mellon,  for applying unfairly disadvantageous rates to their foreign exchange executions.

Perhaps based on the custody agreement that they signed with BNY Mellon, the states are right, and should get some money back.  But I think there is a significant element of "buyer beware" in these types of transactions.  If you are running an internationally invested pension fund that converts millions of dollars on a regular basis, you need to make sure on a regular basis that you are getting competitive rates.  You need to negotiate and shop around until you get them--not accept your bank's daily rate because (perhaps) it is operationally convenient.

To me, using standing instructions with your global custodian to convert large amounts of funds "automatically" at their daily rate is like using the valet service at the Hyatt Hotel to do 30 pounds of laundry.  Everyone knows its a rip-off and a cash cow for the provider.  If you're in a pinch, let them wash one or two pairs of underwear for you, but unless you have money to burn, don't give them the whole sack.  OK, maybe this is not common knowledge, but if you are managing big money and hiring custodian banks it should be.

BNY Mellon is the largest of a handful of huge players in the global custody world (along with State Street, JP Morgan Chase and Citi).  They now have over $25 trillion in assets under custody.  Since the 1990's they have been at the forefront of what has been a massive shake-out in the global custody business -- small and middle-sized providers have all but disappeared as  BNY have used their "economies of scale" to aggressively lower their prices and either take clients, or buy competitors out wholesale.

data from BNY Mellon annual reports

But asset servicing (another word for custody) is not free.  It costs money to settle trades, to collect and record dividends, to wire money, to issue statements, to withhold taxes, to report to government regulators.  Clerks have to do most of this.  You can try to save money by cutting the number of clerks you hire and automating these processes as much as possible, but then you have to hire more skilled and expensive staff to do the automation, and to solve the messy problems that result when the automation doesn't work as expected.  

The fact is, by marking down their fees so aggressively (they average around 1 basis point or 0.01% of assets under custody), banks like BNY Mellon have put themselves in a situation where there is a constant hunger for costs reduction (ie, cutting heads) and revenue enhancement.  Foreign exchange has been an important revenue source for global custodian banks, at least since I first studied the topic back in the early 1990s.  They need the revenue, the same way that a bar that gives away free food needs to sell drinks.  No, their rates are not competitive, and their method of calculating them is not transparent.  But if you are an investor in international markets you should know what a fair rate is, and there is nothing stopping you from going out and negotiating your own forex deals, either with the custodian's own funds desk or with a different counter-party.

Now, whether BNY Mellon's rock bottom fees are an example of monopoly pricing is a completely different issue.