Category: capital

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Coronavirus to cost insurers more than $200bn

By Oliver Ralph, FT today.

Just over half of the $203bn estimated loss relates to claims, with insurers expecting to pay out for events cancellation, business interruption and trade credit cover. Another $96bn comes from investment losses, where turmoil in financial markets has hit the assets insurers hold to fund claims. “This is a loss of a magnitude that none of us have seen in our lifetime,” said John Neal, Lloyd’s chief executive.

But that is general insurance.

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Can UK Banks Pass the COVID-19 Stress Test?

Source: Positive Money

Eumaeus is pleased to release our report Can UK Banks Pass the COVID-19 Stress Test? on the dire state of the UK banking system.

In his final remarks as Governor, Mark Carney reiterated the same upbeat message that he has always given, that the UK banking system is superstrong:

Some watching will recall the financial crisis a little more than a decade ago. Then, the financial system was the core of the problem. Now, it can be part of the solution.

Over the past decade, the UK financial system has been transformed. We didn’t build this strength for its own sake.

This is prudence with a purpose.

Resilience with a reason.

Deputy governor Sam Woods said much the same to the Treasury Committee on Wednesday April 15th:

We go into this with a well capitalised banking sector.

We don’t think so. Our report explains why.

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Hegel on an Off Day: Kevin’s Response to CP 2 20

Last week Eumaeus posted Dean’s response to the PRA’s Consultation Paper CP 2 20.

Here is mine.

My first impression about CP 2/20 is one of overwhelming bafflement. The PRA has a statutory duty to consult when proposing new rules, but there is also an implied obligation to consult clearly and intelligibly.

It is one thing for the Regulatory ‘Will’ to be inscrutable, but it is quite another when that Will becomes inscrutable to the point of unintelligible. CP 2/20 reads as if it could have been written by Hegel on an off day.”

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UK Shareholders’ Response to Consultation on Capital Requirements and Macroprudential Buffers

On the UK Shareholders website here.

UKSA has submitted a response to the Prudential Regulation Authority’s Consultation Paper CP2/20 on Capital Requirements and Macroprudential Buffers

In a critical submission, UKSA has drawn the Authority’s attention to the lack of clarity and intelligibility of the Consultation Paper and argued that the proposed reduction in Pillar 2A is not contingent on any increase in the countercyclical buffer, leading to the asymmetry of an actual lowering of minimum capital requirements offsetting a hypothetical increase to the buffer.

I have written a few CPs in the past, but for sheer impenetrability this one takes the biscuit.

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Coronavirus exposes illusion of UK bank capital strength

A great piece here by Jonathan Ford of the FT. For those on the wrong side of the paywall, his case is as follows.

The Bank intervened last week to stop banks paying out dividends, the official reason being the coronavirus panic. But why didn’t the Bank prevent capital distributions earlier, given the much-heralded capital rebuilding exercise? Ford argues that the official measure of capital strength, CET1, may be illusory, given that it is based on ‘risk weighted assets’, a subjective and hence gameable measure of asset value.

A less gameable measure involves comparing equity not with a RWAs, but simply the total unadjusted asset number. Moreover, because accounting measures of book equity are backward-looking and may conceal losses, it makes sense to use the bank’s market capitalisation in their stead — especially when events are moving fast.

He quotes our own Professor Dowd saying that Barclays’ leverage ratio (equity divided by unadjusted asset value) is now just 1.2 per cent.

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Letter from Sam Woods to insurers on distribution of profits

Here.

When UK insurers’ boards are considering any distributions to shareholders or making decisions on variable remuneration, we expect them to pay close attention to the need to protect policyholders and maintain safety and soundness, and in so doing to ensure that their firm can play its full part in supporting the real economy throughout the economic disruption arising from Covid-19.

[…]

In the current situation of high uncertainty, it is therefore critical that insurers manage their financial resources prudently in order both to ensure that they are able to meet the commitments they have made to policyholders in a way that is consistent with the expectations of the Financial Conduct Authority, and to enable them to continue to invest in the economy.

But that is odd though. The whole purpose of the Solvency II regime is to provide the necessary safety and soundness through model-based, PRA-approved capital management. A 100% coverage ratio corresponds to a 1 in 200 probability of default, and to my knowledge, no firm is allowed to operate under the soft limit of 130% capital coverage, which corresponds (by my mathematics) to a probability of lower than 1 in 2,000 years.

So why the worry, Sam?

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Just the spread changes

Data source: ICE BofA US Corporate Index Option-Adjusted Spread, and Eumaeus

The chart above shows estimated losses on the recent credit spread movements on the corporate bond exposure of a firm like Just Group. First of all, let me state I have nothing against Just, which I am using as an example. My target, as always, is the regulatory system that approved the capital position of such a firm in the first place.

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Crisis wot crisis

From our friends at the Bank today:

In response to the material fall in government bond yields in recent weeks, the PRC invites requests from insurance companies to use the flexibility in Solvency II regulations to recalculate the transitional measures that smooth the impact of market movements.  This will support market functioning.

Transitional measures are a fake regulatory asset that can be used create capital to replace what is lost when liabilities rise through, e.g. fall in long term discount rate.

We could use this method to address the current epidemic. Instead of causing an epidemic by reporting the number of diagnosed cases, simply change it to a lower number.

Problem solved.