Citi CEO Vikram Pandit wrote an Op-Ed for the Financial Times about regulation called ‘Apples vs. apples — a new way to measure risk.’ The piece tackles capital requirements, and proposes a new way to measure them industry-wide.
Pandit opens by saying he supports Dodd-Frank and other regulation but still has qualms about the way regulators measure new government imposed capital requirements.
Bottom line: the current measurements do not allow regulators to truly judge how much cash a bank should keep in relation to what it’s holding, especially not with non-bank institutions.
So what should we do according to Pandit? He says we need to create a standard, 100% public “benchmark” portfolio of assets that an institution is likely holding. That way, regulators will have an idea of how much risk a bank should be taking on:
Institutions would be required to produce, on a quarterly basis for that benchmark portfolio, a hypothetical loan/loss reserve level, value at risk, stress-test results and risk-weighted assets. Right now these measures are run only against an institution’s actual portfolio and only a limited number of the results are disclosed. Worse, those results have no common frame of reference. The benchmark portfolio would supply that needed frame of reference.
How a given company’s risk measurements perform against the benchmark portfolio tells the world how its management thinks about risk, and so just how conservative or risky its own portfolio probably is. An institution that cheerfully reports minimal expected losses from the benchmark portfolio in the event of a one-in-a-thousand market decline is probably understating the risk in its own portfolio. By contrast, one that predicts significant losses from the benchmark portfolio even from a routine decline is a firm that is very conservative about risk.