Enhancing the Risk Disclosures of Banks November 13, 2012 at 5:25 pm
I have been reading a useful and timely report on enhancing bank risk disclosures. Their objectives are sensible, and seven fundamental principles are suggested:
- Disclosures should be clear, balanced and understandable.
- Disclosures should be comprehensive and include all of the bank’s key activities and risks.
- Disclosures should present relevant information.
- Disclosures should reflect how the bank manages its risks.
- Disclosures should be consistent over time.
- Disclosures should be comparable among banks.
- Disclosures should be provided on a timely basis.
As many commentators (notably Bloomberg’s Jonathan Weil) have pointed out, we are far from this world right now.
The report goes on to give a lot of reasonable detailed recommendations. This is what they have to say on overall capital requirements disclosures, for instance:
[Banks should] Present a table showing the capital requirements for each method used for calculating RWAs for credit risk, including counterparty credit risk, for each Basel asset class as well as for major portfolios within those classes. For market risk and operational risk, present a table showing the capital requirements for each method used for calculating them. Disclosures should be accompanied by additional information about significant models used, e.g. data periods, downturn parameter thresholds and methodology for calculating loss given default (LGD).
And here is the first of four paragraphs on market risk:
Provide information that facilitates users’ understanding of the linkages between line items in the balance sheet and the income statement with positions included in the traded market risk disclosures (using the bank’s primary risk management measures such as Value at Risk (VaR)) and non-traded market risk disclosures such as risk factor sensitivities, economic value and earningsscenarios and/or sensitivities.
It sounds elementary – of course you would want that – but it is a measure of how far banks’ disclosures fail to meet the standard of `what a reasonable person trying to understand the firm would ask’ that I cannot think of a single large bank today that meets that requirement. There is a lot of information in annual reports and Basel pillar 3 documents, but there is a lot that is missing too. These recommendations are a very good step towards filling in the gaps.
Banks will of course push back on this. The last thing that most of them want is (in the words of paragraph 26) to `provide information that facilitates users’ understanding of the bank’s credit risk profile, including any significant credit risk concentrations’. That is short sighted: investors would trust banks more if they could understand them. The reason that many trade below book is their opacity, and enhanced disclosure is the only solution to that.