How to ensure transparency and credibility in banking

I don't fully subscribe to this, in that any commercial organisation would never be this transparent, nor should it be.  It wouldn't be in the stakeholders' interests either for an organisation to be so open about its position, strategy, etc., as it would be giving up their competitive advantage.

However, what should happen is that the institutions should be completely open with the regulator - as used to be the case with UK clearing banks being accountable to the Bank of England.  we need to get back to that situation, so that someone, somewhere, can exercise restraint on these organisations.  If people could have faith that they were being controlled by a central, competent and powerful organising body, then that should be enough.

Oh, and we need to see the end to these exotic financial instruments.  I think it is absurd, for example, that a bank can buy insurance against the default of a loan that they granted.  They did the credit assessment in the first instance, and it must be their responsibility to manage that loan (or overdraft) to successful conclusion.  I can't see how an insuring organisation can agree to take on that risk without the kind of credit analysis that the bank should do (or should have done).

Similarly, it must not be possible for them to seel on those loans, packaged up with others in an opaque wrapper.

The availability of both these instruments enables the shifting of liability away from those making the initial decision, to someone else, with all that implies for expanding the business without proper controls.

Get rid of these things, and restore the authority of competent central banks over the banking systems, and confidence should come back.

Credit appraisals, based on which a bank grants mortgages, are based on facts from the past / present and assumptions about the future. e.g. borrower's employment status, income. Like anyone else, banks are not perfect crystalball gazers all the time and therefore carry the risk that their assumptions about the future prove wrong. Insurance helps them mitigate that risk. To that extent, I fail to see any basic disconnect between granting a mortgage on the one hand and taking an insurance against default of that mortgage on the other.

Besides, if banks are able to buy insurance, it means someone is willing to sell it to them. By itself, this should suggest that there is nothing fundamentally wrong about this process.

We hear so much buzz around how regulators should stop banks from repackaging dubious assets and selling them off as Triple-A securities. How about some regulations to prevent corporates and financial institutions (e.g. pension funds) from buying such securities, and to ensure that rating agencies really understand what they are rating and don't grant anything better than junk-bond status to them?

Roger, thanks for bringing in a different perspective. I understand your argument and reasoning behind it however, it is important to remember that in addition to the shareholders; banks and other financial institutions are also trustees of their depositors. Some of whom are small and some big, and also constitute the public at large who have a right to know how their funds are being managed and secured. In addition, considering that when things do take a turn for the worst, and public funds are relied upon to bail out the banks – then it only seems fair that this safety net provided by the public should come with a degree of transparency. As well as ensuring that the depositors’ money is kept safe and that the banks are able to provide them with the best returns possible, it will also provide peace of mind to the investors and public at large.

Furthermore, while exotic and OTC derivatives may not necessarily be bad, there is a need to bring in more transparency in how the risk is assessed on these and how this risk is priced. Similarly, Asset Backed Securities serve a useful purpose, but there is a need to ensure that there is greater diligence in packaging and pricing them, and that this diligence is made transparent to all the stakeholders.

While I agree that compliance to a regulatory framework is a must-have, there is a need to go a step further. That is the need for the whole banking system to win back the trust of all the stakeholders including the public at large. Many people, albeit misguidedly, lay the blame for the ongoing financial crisis entirely at the feet of the banks and weather true or not, this is a PR issue that they need to win at all costs to retain their customers and secure their future.

What is more, this is all very easy to achieve simply by having the right systems in place, and ensuring the data these systems capture is the same data that is reported to the regulators.

Ketharaman, thanks for echoing the sentiments expressed in my original write-up. As you rightly pointed out – if there is a demand for an instrument, it will be supplied and hence, it is not possible to wish away Mortgage Backed Securities, CDS’s and CDO’s. I whole heartedly agree that the need of the hour is to ensure that trust is brought back to the system by ensuring greater transparency backed by the appropriate system support.