Banking StandardsWritten evidence from Nomura
Nomura is grateful for the opportunity to respond to the Parliamentary Commission on Banking Standards’ pre-legislative scrutiny of the draft Financial Service (Banking Reform) Bill call for written evidence.
As a pure-play, international investment bank operating in London with a Japanese heritage, we believe we have a unique perspective that we hope will prove useful to the Commission.
We have played a significant role in the UK banking sector over recent years, advising several UK banks and participating in the recapitalisation of the banking industry. Our experience has given us some useful insights, specifically on bail-in, and we welcome the chance to share our views with you.
We have framed our response against this backdrop, providing opinions where we feel we can add value, rather than answering every question. We have been actively engaged in the Independent Commission on Banking and have submitted to both the Issues Paper and the Interim Report issued by it. The views expressed in this paper closely reflect our submission to HM Treasury’s White Paper on Banking Reform, but we feel it would be useful to share these views directly to the Parliamentary Commission on Banking Standards
We comment on the new twin peaks supervisory structure; we have some suggestions for limiting ring-fenced banks’ activities to enhance the banking system; then we explain our views on bail-in given our experience in the recapitalisation of Europe’s banks.
We elaborate our points in more detail below.
Twin peaks supervisory structure: We support the new regulatory structure and are closely following the regulatory structure developments in the UK in preparation for the formal move to the Prudential Regulatory Authority (PRA) and Financial Conduct Authority (FCA). Regulatory certainty provides financial institutions with the basis they need to make important decisions about allocation of resources. We would suggest that transposition of continuity objectives should keep in mind the division of responsibilities between the PRA and FCA and minimise the opportunity for regulatory conflict.
Financial products and ring-fenced institutions: We support the measures suggested outlined in the Bill to restrict the scope and scale of securities-trading by ring-fenced banks. Given that one of the key aims of the ring-fence proposals is to make the banking system safer, ring-fenced banks should not be permitted to engage in securities markets as principals as this may increase systemic risk.
Further, we would suggest:
Ring-fenced banks may be permitted to engage in simple interest rate swap transactions or foreign exchange hedging, but should be prohibited from engaging in equity-related, commodities or exotic derivatives products; and
Ring-fenced banks may be permitted to engage in the above-mentioned derivatives activities only if it can be clearly demonstrated that so doing is of benefit to their customers, particularly SMEs.
Ensuring banks are adequately capitalised: Nomura understands the need for a statutory bail-in tool to ensure that some unsecured liabilities can absorb losses outside of insolvency and liquidation to facilitate a resolution. We believe the bail-in process needs to be uniform across different jurisdictions so we would fully support moves towards international implementation of the bail-in tool.
We have two over-arching comments in relation to bail-in and non-viability. First the market needs precise definitions around what bail-in is and when it would take place. Second, the market needs reassurance that the hierarchy of claims will be preserved in the event of resolution.
We would make a number of further points relating to specific questions in the consultation:
The bail-in tool should be used only as a resolution tool and not as a recovery tool. In other words, it should be used only at the point of non-viability to facilitate the resolution of systemically important institutions.
Banks’ weighted average cost of capital has clearly been affected by the reduction in the value of the implicit Government guarantee. Before the crisis, banks’ cost of capital was artificially low, thanks to taxpayer support. This allowed banks to offer artificially low cost of credit. Now that support is no longer there, the cost of capital has risen. In fact, it is higher than it might otherwise be because there continues to be uncertainty about the process under which the point of non-viability will be determined as well as the consequences of such determination. This makes investors wary about investing in unsecured bank instruments. In addition to this, the market could better screen the resolvability banks if a clear mechanism was established so that investors could recover capital through simple structures rather than complex ones. The sooner the market has clarity around this issue, the more prepared investors will be to invest in bail-inable debt, and to motivate banks to become more resolvable. This will reduce the cost of capital and with it, the cost of credit.
In addition, there needs to be absolute clarity around bank resolution, including a strong legal framework which will promote market liquidity, lower the cost of capital for banks and reduce the cost of credit to their customers.
Investors in banks understand that there will be no bail-out and they may have to suffer losses even outside of insolvency and liquidation. The market is generally able to assess and to price that risk but it puts a substantial premium on uncertainty and is particularly concerned by the lack of a credible mechanism for preservation of the hierarchy of claims at the point where losses have to be absorbed by fixed income instruments.
There needs to be transparency regarding the extent of encumbrance of bank assets by, for example, the issuance of covered bonds.
Debt issued under foreign law should include contractual provisions to ensure that, for the purposes of bail-in, they are subject to UK law. This is an existing requirement for regulatory capital-qualifying subordinated debt.
Loss-absorbing capacity should be measured by reference to balance sheet size, as proposed by the European Recovery and Resolution Directive, as opposed to risk-weighted assets, as proposed by the Independent Commission on Banking. This will provide an additional safety valve to ensure that capital measures are not overly-dependent on internal risk-based models. This should reduce variation between jurisdictions and individual banks and therefore increase the comparability of capital ratios.
31 October 2012