The global financial system might not be as stable as we thought.
Earlier this week, Sir David Tweedie, chairman of the International Valuation Standards Council announced his worries about the valuation system used by global banks.
It has become clear that the methods used by investors, regulators and auditors to measure the health of a banks’ assets are fundamentally flawed. This is due to the value of individual financial instruments and their associated risk being determined by the bank and not measured by a common metric. This means that the value of banks assets are incomparable, because there are no valuation benchmarks or agreed methods of calculation. Basically, each bank can determine its own value by 'risk-weighting' its assets. Who determines the risk? Well, the bank of course... and therein lies the fatal flaw.
Sir David argues that the valuation of complex instruments is so varied that it undermines current income statements, balance sheets and capital adequacy buffers.
Without consistency in the valuation of assets, we will soon be facing yet another global financial crisis. After the financial crisis of 2008, the 'Group of Twenty' and the Financial Stability Board have identified the need to improve valuation standard, consistency and transparency by introducing Basel III. The shortcomings of Basel II lead to the financial crisis and it looks as if the same might happen with Basel III. Basel III is barely applied to financial institutions and there is already talk of international regulators gearing up to make significant changes to capital requirements over the following years to come. They plan on making alterations to the Basel III international accord, which includes raising the risk-based capital ratio, revising risk weightings, and moving away from model-based assessments as part of a revamp of the capital requirements for operational, market and credit risk. But how long will it take to implement these changes if Basel III, which was already agreed upon in 2010, only started being implemented recently. Will it be soon enough to save us from (yet another) global financial crisis?
Knowing these threats in advance helps us prepare for the worse. Here at STRIDE we are risk-averse and do our best to buffer ourselves and our clients against stressful financial situations, such as market crashes. We regard ourselves as quite unique in our approach, staying ahead of the curve and protecting ourselves against global risk.
Since we built STRIDE in 2008 we have ensured that banks have true T1 capital ratios to be safe, not risk-weighted. We have also made banks maintain a Leverage Ratio since 2008, something only agreed by the Third Basel Accord (BASEL III) in 2010 and only introduced in 2013.
Why did we do this?
Allowing banks to risk-weight their own assets is precisely how we got into the global financial crisis in the first place. If one assumes that all money lent at a bank is at risk and that you have to measure how much the bank is lending in total against not only it's assets (as these are often at risk too) but against its shareholders equity, you start to find out which banks are truly healthy and which ones are gambling with their depositors funds. We don’t believe in gambling, so we certainly don't invest in gamblers. We believe in investing with a margin of safety, securing our financial futures and enjoying market-beating returns.