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Faced with regulation that has changed and will continue to alter the banking world, top bankers are trying to persuade us that the proposed changes are not just bad for them, but for everyone. The erstwhile masters of the universe have complained especially bitterly about the Basel III rules which, if they are to be believed, will end banking life as we know it.

Unfortunately for these chief executives, they are failing to lead and shape the discussions around how best to police their businesses and account for and measure the risks they pose. Their complaints are many; however, few of the alternatives they have proposed have won much currency with lawmakers and regulators. Moreover, investors seem to be making up their own minds about banks' valuations and risk profiles, regardless of what chief executives say.

Dimon and Pandit lone voices

Jamie Dimon of JP Morgan Chase and Vikram Pandit of Citigroup are two chief executives who have waded into the debate on Basel III and other pieces of regulation more vocally than their peers. Dimon's sometimes volatile stance on regulatory matters has shocked some in the industry and has not impressed the regulatory community. Pandit's moderate approach has, however, been seen as a thoughtful attempt to start a conversation about how the financial services industry can most usefully meet regulators' heightened expectations.

Their counterparts at Bank of America, Barclays, Goldman Sachs, Morgan Stanley and others have taken a less public approach, making little attempt to forge an industry-wide response to the unprecedented amount of financial regulation that is coming their way. These are people who are not collaborative by nature. Competition among the world's largest financial institutions, their varying motivations and strategies are all reasons bankers have not been able to band together and fend off regulators in a meaningful way.

PJ Di Giammarino, chief executive of JWG Group, told Thomson Reuters: "Seventy thousand pages of 2011 regulatory 'dialogue', and the differences in the detailed discussions about the rules, have strained a number of the traditional mechanisms, like trade associations, that banks used to have to get a consensus of opinion and to get a message out to the breaking point. Therefore, Citi's views may be a signal of things to come, where individuals at large banks choose to lead the conversation on regulatory issues. We're likely to have more of this individual banter rather than collective thinking."

Throwing money at the problem

One thing all the big banks have in common, however, is the amount spent lobbying lawmakers. According to the Center for Responsive Politics, a Washington, D.C.-based group that tracks corporate spending on lobbying, the amount spent by financial services firms on Capitol Hill was up 6.2 percent as of the end of the third quarter last year. In 2011, securities and investment firms spent a whopping $74.8 million, and commercial banks $46.9 million.

Among commercial banks, JP Morgan was one of the biggest spenders at $5.8 million, while Citi spent $3.8 million on lobbyists. Barclays spent $2.48 million, while Bank of America spent $2.2 million. Goldman Sachs and Morgan Stanley spent $3.2 million and $2.25 million, respectively.

Despite the huge amount spent coaxing regulators to change the proposed rules, banking lobbyists remain unpopular in Washington. Moreover, the new rules and regulations considered to be most damaging to banking-as-usual are unlikely to change much before implementation. The Dodd-Frank Wall Street Reform Act 2010, which includes rules that will curtail derivatives and proprietary trading, is expected to be largely implemented as drafted. In addition, the Federal Reserve has indicated it intends to adopt Basel III with few, if any, alterations.

Earnings season brings more Basel criticism

The latest round of earnings statements has brought more comments on Basel III's regulatory capital requirements as well as the host of regulation set to come into force in the medium term. What the fourth quarter results for 2011 show is that the days of bumper banking profits and the attendant bonus extravaganza are over, at least for now. Unhappy with the new reality, Dimon and Pandit have once again rounded on Basel III, each in his own way.

In September, Dimon railed against Basel III in a headline-making rant aimed at Mark Carney, then a Bank of Canada governor. That tirade was widely viewed as damaging to the banks' cause, but Dimon has continued his public excoriation of what he considers anti-American regulation.

Dimon's criticism of Basel III and wider regulation was somewhat less inflammatory during a recent JP Morgan earnings call. He called European regulatory policy "contradictory" and said that any clarification on capital rules showed they were "clearly bad".

Pandit's benchmark portfolio

Pandit has chosen the Financial Times' comment pages to express his views on regulation and Basel III. Most recently, he wrote apiece arguing against the use of capital requirements based on regulators' judgement of the riskiness of assets. Instead, Pandit called for regulators to create a benchmark portfolio against which all financial institutions could measure their risk. He argued that his approach would allow investors to compare financial institutions' riskiness, and therefore market value, on an apples-to-apples basis.

Pandit has been credited with being perhaps the only top banker to voice his views and start a conversation about new the risk measurement requirements needed under Basel III. Di Giammarino explained that when regulators try to implement new rules they end up leaving them too vague. That creates situations where regulations are applied practically on a firm-by-firm, situation-by-situation basis. Naturally, the industry is seeking some clarification.

Di Giammarino said: "This is a very healthy conversation to be having. To me, Pandit is asking for standards. He's saying to the regulators, 'give me a definition of what good looks like to you'. I can only applaud him for being out there in front at this time, saying, 'this is a better way to think about some of the current issues'."

Call for light touch regulation?

While a few analysts and even Carney, now the Financial Stability Board (FSB)'s new chief, thought there was some merit to Pandit's apples-to-apples plan, it has come in for some criticism from prominent academics.

Robert Engle, professor of finance at the Stern School of Business and 2003 Nobel Laureate in Economics, told Thomson Reuters: "It seemed [Pandit] was saying that we should measure the riskiness of a bank's portfolio based on some benchmark portfolio and not by whatever the bank is doing. That doesn't make any sense at all. Why don't you want to use higher risk weights for banks that are taking more risk? Why should all banks have their risk measured by the same benchmark portfolio? Who's going to decide what this benchmark portfolio is and how it changes over time? Are we supposed to look at individual bank portfolios to see their positions before we create the portfolio?"

"I think this is a statement saying, 'let's do regulation with a light touch that's not so intrusive, where we can come up with some natural measure of risk rather than using Basel risk weights or regulators' intuitions'," he added.

Other experts have suggested that letting banks use a benchmark like the one Pandit proposed to measure banks' relative riskiness could be harmful. Jon Danielsson, reader in finance at the London School of Economics, told Thomson Reuters: "It would be so easy for the banks to game this, report what they want for this benchmark portfolio, and do whatever they want outside of it. As a consequence if this is not going to provide useful information, it will just be confusing and perhaps provide false confidence."

Creating a benchmark portfolio, such as Pandit has suggested, would probably not bring much clarity to the risks banks are taking. Danielsson argued that financial institutions would always want to look good when measuring the risk in such a benchmark portfolio. What would be likely to happen is that financial institutions would all report risk numbers that were the same or very similar. No financial institution would want to come across as too risky or too conservative. They would cluster somewhere between the two extremes.


“ There is very little transparency in the system today. ”

— PJ Di Giammarino, JWG Group


Danielsson added: "The problem is financial institutions can tune the risk model to generate the numbers they want for the benchmark portfolio that is not going to say all that much about the general assets they hold. The actual portfolio might be a lot different and if they want to take a lot of risk, they can easily do that while reporting the risk number they want for the risk benchmark portfolio. I don't really see much value in it."

But Di Giammarino said that while every bank was different, there was a certain amount of commonality in their activities. He suggested that Pandit's benchmark proposal was a natural evolution of where the regulatory approach was taking the industry anyway.

"[Using such a benchmark] you're creating a healthy dialogue. You can accuse anyone of fixing the books and doing bad things in the reports, but it would be a phenomenally better system than what we have today. There is very little transparency in the system today," he said.

Investors rating bank risk themselves

Investors are, however, increasingly making their own judgements about banks' valuations and the risks they run. Last year, 59 percent of buy-side respondents to a Thomson Reuters Poll said that they had reduced their exposure to banks because they were concerned about a lack of risk controls. Respondents said banks did not have adequate systems and resources to cope with the diversity and complexity of the risks they faced. Indeed, it was also observed that banks simply did not have enough information to understand the risks to which they were exposed.

In addition, investors have been using new research tools like NYU Stern's Systemic Risk Rankings and independent research firm CreditSight's Euro Bank Stressometer to add to their understanding of banks' riskiness and the overall exposures.

Engle said: "Investors are charging a much higher risk premium for the banks than they used to. They are doing their own evaluations of the quality of the assets the banks have. They're marking down the sovereign debt even if the bank accountants aren't. Stock valuations are probably not a bad estimate of what the value of these companies really are."

Bankers know best?

Banks prefer to set out their own views on the worth of their businesses and tend to be sceptical of market valuations. In part, what bankers like Dimon and Pandit seem to be saying to regulators is that, despite what happened in the financial crisis, banks are still in the best position to measure their risk and value their businesses.

Whether the kind of risk benchmark Pandit has suggested would allow investors to make an apples-to-apples comparison is debatable, but at least he is trying to start the conversation on this important issue. His silent colleagues ought to chime in with some constructive contributions to this discussion before their ability to influence regulators and investors evaporates completely.