Today, The Basel Committee on Banking Supervision announced a new strategy to address shortcomings in its own global regulatory structure. The proposal creates new capital requirements, leverage ratios, and risk measurements designed to more carefully regulate banking practices across the globe. The proposal includes the following elements:
# strengthening the risk capture of the Basel II framework (in particular for trading book and off-balance sheet exposures);# enhancing the quality of Tier 1 capital;# building additional shock absorbers into the capital framework that can be drawn upon during periods of stress and dampen procyclicality;# evaluating the need to supplement risk-based measures with simple gross measures of exposure in both prudential and risk management frameworks to help contain leverage in the banking system;# strengthening supervisory frameworks to assess funding liquidity at cross-border banks;# leveraging Basel II to strengthen risk management and governance practices at banks;# strengthening counterparty credit risk capital, risk management and disclosure at banks; and# promoting globally coordinated supervisory follow-up exercises to ensure implementation of supervisory and industry sound principles.
Strengthening liquidity and solvency requirements seem like regretful afterthoughts during a time of historically low liquidity and high insolvency, but better late than never. One does wish that the Basel Committee had applied these measures as forethoughts rather than afterthoughts, but that's human nature.
There are three elements missing that I hope to see emerge in 2009:
1. A Global Loss History DB of anonymous credit, market, and operational incidents, events, and losses from every Basel conforming institution. Individual institutions do not have enough loss history to compare their past exposures and "claims" to trend and forecast. Industry and geographic loss information is needed to better inform decision-making at banking institutions. 3rd Party loss data is available to every insurance company for all lines of business. Only the banking community could conceive of risk measurement programs without 3rd party institutional validation.
The Operational Risk Exchange has been aggregating banking loss data for operational risk among the 41 banks who participate in that consortium for 3 years. That model is valid, but the sample size is too small even for ORX. I hope the Basel Committee sees ORX as a valid architype that should be replicated worldwide with each Central Bank collecting the anonymized loss data from each member institution and sharing that loss data worldwide so that all financial institutions can compare their own loss trends to global trends and forecast future exposures more accurately.
2. An XBRL for Risk Reporting Taxonomy. Banks can't report loss events without a global taxonomy so that everyone can agree on what to call things and what things mean when they are reported. Even within banks, the word Risk has many different meanings to different people. For business people, Risk is an omnipresent feature of life, an attribute to calculate potential returns or losses in investments. Many business careers are made by taking risks. For an IT person, Risk is something to be avoided at all costs, the result of flaws in architecture that lead to vulnerabilities and loss. Many IT careers are lost by taking risks.
Business and IT can sit at the same table and have exhaustive conversations about Risk, each thinking they understand the other, and walk away having fundamentally different idiomatic understandings of what was discussed. That misunderstanding is often a source of new risk.
XBRL (Extensible Business Reporting Language) is an XML language for describing business terms, and the relationship of terms, in a report. It enables semantic clarity of terminology, and that clarity is absolutely essential for the accurate recording and reporting of credit, market, and operational incidents, loss events, and losses.
A Risk Taxonomy is like an alphabet - the letters alone convey no meaning, but they are the foundational elements that allow humans to understand each other. We desperately need a new alphabet to describe Risk - incidents, events, losses, claims, exposures, forecasts, reserves - so that firms everywhere can aggregate loss information, analyze it with standard actuarial methods, compare past exposures to present conditions and opportunities, and forecast potential outcomes to illuminate options.
A year ago, I wrote on this page about the need for new macro-economic tools to enable Central Banks to measure aggregate risk taking in the financial world. An XBRL Taxonomy of Risk is a fundamental building block to enable interoperability and standard practices in the measuring and reporting of risk. Those standards in turn will enable Central Banks to manage vast databases of loss history and trend analysis that will inform policymakers and member banks to make better decisions that produce better returns. We will still need new information management software and governance models to make sure the right information gets to the right people at the right time, but none of that is possible without a standard alphabet and vocabulary to describe what's being recorded and read.
Recently, I announced an IBM Data Governance Council initiative to develop an XBRL Taxonomy for Risk. We are inviting all interested parties - banks, broker/dealers, hedge funds, consortia, think tanks, and regulators - to participate in this initiative. We will be working closely with XBRL International and XBRL.US to share ideas in an open and transparent process to bring forward a standards proposal quickly. If you are interested in participating, please drop me a line.
3. Lets bring back Glass-Steagall. Gee what a great idea. No leverage ratios, because investment banks can't leverage with bank deposits at all. Banks, Brokerages, Hedge Funds, and Insurance Companies all need to have their activities segregated. It isn't enough to insist on new solvency, liquidity, and risk measures. We need to separate temptation from action. And when all three of these things are done - new solvency requirements to shore up assets on the balance sheet, risk taxonomies and loss history data to forecast future exposures, and Glass-Steagall V2 - we'll have risk tied up in a knot... until it's not.[Read More]
Adler on Data Governance
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On October 9th, as stock markets around the world were plunging, and the US election was about to pop, President Bush invited G7 finance ministers to the White House for an urgent summit on the Credit Crisis. During the meetings on the 9th and 10th, Treasury Secretary Hank Paulson urged the Europeans to back the recently ratified US plan to buy up toxic debt assets from bank balance sheets. He wanted to calm global markets with a common bailout strategy driven by the White House.
But the Europeans had other ideas.
They had been listening to their Swedish colleagues describe how the Swedes had dealt with their own national credit crisis in 1997. The Swedish solution, which worked very well, called for direct capital infusions into banks in return for preferred stock shares. Gordon Brown, Prime Minister of England, had already been calling for that strategy earlier in the week. The Europeans were also not at all inclined to follow US leadership in a crisis caused in large part by US financial mismanagement.
So on Saturday the 10th, the G7 issued a bland statement about the importance of coordinated action and the Europeans flew to Paris, where on Sunday they issued their own statement announcing their adoption of the Swedish option. On Monday, October 13th, Secretary Paulson met with the CEO's of 8 top US banks and handed them a piece of paper which they had to sign before leaving. The paper stated that the US Treasury Department would be making mandatory capital investments in each of their institutions in exchange for preferred stock. By 6:30pm, all the CEO's had signed and the Americans had followed the lead of the Europeans.
In London, Paris, and Berlin, this about face for the US bailout plan was seen as a stunning political victory. The finance minister of Germany declared on the floor of the Bundestag that the era of US financial supremacy was at an end. Newspapers and talk shows across Europe herralded the new age of EU financial regulatory supremacy. At a conference I attended in Athens in late October, the EU officials I met were flush with regulatory victory. The facts of the G7 meeting were lost on no one.
In the US, Americans were far too consumed with the presidential elections to care about what the Europeans thought. In many of my conversations with economists, business people, and regulators, most Americans didn't even understand what had happened over the weakend of October 10-11.
Let me state what happened in the most clear and unambiguous terms - The Bush Administration lost control of the post-Bretton Woods financial order. Since that meeting, the EU has been talking up the need for global financial regulation and is pressing for new powers and funding for the IMF. The lame duck Bush Administration has no power to resist.
Last week, Angela Merkel, suggested that what the world needs is a World Map of Risk, some kind of global dashboard that will peer through the complexity of financial derrivatives and complex credit default swaps to illustrate trouble spots and areas needing more EU regulatory oversight.
This is a bad idea for several reasons:
1. People causing financial risk have more financial incentive to hide it than share it.2. It is age-old cultures in financial firms that create incremental risks that rise to systemic failures. 3. The only regulatory reform that will work is the kind of business segregation that Glass-Steagall provided from 1934 to 1999. And even then, regulators will need to expect creative entrepreneurs to invent new ways to make money that evade regulatory definition.4. The European Union repealed their banking segregation laws in 1993 when they opened up the common market for labor and banking across the EU. And even though that law and the US Financial Services Modernization Act of 1999 prohibited so called "Universal Banks" from investing bank deposits in financial markets, these institutions used leverage ratios to skirt the regulations.
Great data can't overcome poor leadership. People make decisions, computers execute. Technology can help people to better measure risk, but only people can decide to govern it.
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On Sunday, President-Elect Obama's transition team indicated that the new administration would appoint a CTO for the entire US Government and that the office of White House Communications would be expanded to include a new social networking interface imported from the Obama Campaign. This new interface would allow the White House to communicate directly with the massive online community created during the Obama campaign, instead of using the TV, Radio, and print publications as media intermediaries to reach American voters.
The first announcement is terrific and long overdue. Washington desperately needs better technology policy advice.
The second announcement is potentially worrisome and raises many as yet unanswered questions. Here are just a few I thought of:
1. The campaign was funded by political contributions. The White House is funded by the taxpayer. Will taxpayer funds now be used to run a social networking site designed to energize political action?
2. The Obama website contains hundreds of online forums where citizens can exchange their political views on any topic. The campaign was extremely open to the expression of views that disagreed with Barack Obama. For example, when Obama voted for the FISA Bill in June, after publically declaring he would vote against it in February, many liberals and liberatarians protested vociferously on his campaign website in forums and email lists. The rage went on for weeks, and the campaign did nothing to tamp it down. Will the White House tolerate these disparate views? Will they even read them if they disagree strongly with Obama public policy positions?
3. And which branch of government will provide oversight over how information about the political views of American citizens are used for political and public policy purposes?
4. Who will protect American citizens from government persecution when policically embarassing views are expressed on the White House social networking site? Before 1978, wiretapping in America was common and law enforecement used that tool to monitor political activists across America. In the wake of 9/11, wiretapping has been used to monitor anyone suspected of terrorism. Is it so far fetched to imagine that a public website devoted to public policy and politics might not also be monitored for dissonant political views? Might that not also produce secret court warrants for wider-scale monitoring, subject to National Security Letters? And even if this administration provides safeguards to protect against that kind of chilling outcome, who will protect us in the future from a different administration in a different time? Data doesn't die after all...
5. The Obama campaign was hacked over the summer, and the US Government is targetted, and hacked successfully, by foreign nations and organized crime all the time. How will the American government protect Americans and their views from falling into the hands of foreign governments. One can well imagine scenarios where Americans travelling abroad are monitored or harassed by foreign governments for the views they express at home. This has happened before.
6. And will the site be at all bi-directional? One can understand why the White House would like direct contact to Americans. It is a very powerful political tool. But will it only be used for political manipulation, to organize citizen participation in White House Policies? Or will the citizens be able to participate directly and influence White House public policies?
In the Swiss canton of Geneva, they use internet voting to enable citizens to vote in legislative propositions sponsored by other citizens and the legislature. In Geneva, any citizen can sponsor legislation by getting 5000 physical signatures on a ballot initiative. The Canton is now studying how to use social networking to enable citizens to collect 5000 digital signatures online for ballot initiatives.
Will the White House lead on this topic and allow citizens to propose policies and organize support directly on the White House social networking site?
7. How will issues and views express on the White House site be brought to the attention of the President? How will anyone know if their voice has been heard?
The Obama White House has an interesting opportunity and challenge ahead of itself. It can use the internet to increase citizen interest and participation in government. It can also jeapardize that interest by exposing citizen views to foreign and domestic abuse.
Campaigning is different than governing. The President-elect must provide public oversight and Congressional Audit into how its new communications strategy is executed. Without accountability, transparency, and Data Governance built into the program at the outset, we should all be VERY concerned about trusting it.[Read More]