Worries over systemic risks of shadow banking and mid-tier banks

Analysts have been warning on the risks of China’s “shadow banking” system – a sector estimated to have as much as RM4.15tril in assets. 

RAMADAN is always a good time for reflection.

This year, I’ve been researching a new TV documentary series, Ceritalah Indonesia, that I’m hoping to shoot by September.

I want to tell the story of how Indonesia, having endured the Asian Financial Crisis in 1997/1998, ousted President Suharto and then launched into the tumultuous “Reformasi Era” before finding some degree of stability under President Susilo Bambang Yudhoyono.

As a result, I’ve been going over recent history – including the roots of the crisis itself.

Now even though I’m not an economist, it’s been a very interesting journey, especially reading about the various bank failures that sparked off and then deepened the crisis.

Back then, banks seemed to be falling like dominoes: Thailand’s Finance One collapsed spectacularly.

This was followed only a few months later by Bank Indonesia’s surprise decision to close sixteen banks.

As the momentum gathered in intensity, one of Japan’s most important brokerage houses – Sanyo Securities was also shuttered.

Just over a decade later, a similar sequence of events was to take place in Europe and North America as Northern Rock, Iceland’s Landsbanki (better known by its British brand-name Icesave) and Lehman Brothers also failed, leaving in their wake a massive dislocation across the developed world.

Now, as I reflect on the events of 1998 and 2008, I can’t help but sense a similar trend emerging to our north – in China.

Indeed, the next global economic crisis could very well start there. Why?

Well, have you visited the many ghostly, almost totally-empty high-rise communities that have sprung up across the Middle Kingdom?

I can still recall wandering through vast and deserted business quarters in Dalian, Tianjin and Beijing.

At the time, everyone told me that China was different ... well that’s what they said about Thailand, Iceland and Spain.

But now after years of over-building: roads, bridges and railway lines, expanding capacity to the highest degree, people are beginning to question China’s growth model.

For many months now, analysts have been warning on the risks of China’s “shadow banking” system – a sector which some estimate to have as much as US$1.3tril (RM4.15tril) in assets.

“Shadow banking”– is simply non-bank lending and borrowing. Investing in hedge funds, venture capital and private equity are all forms of “shadow banking”.

There’s nothing wrong with this: shadow banking often helps individuals or businesses that would otherwise not qualify for conventional bank loans or get credit.

Also, some shadow banking wealth management products offer lucrative returns.

Shadow banking thrived in China with the liquidity that flooded the market in 2008, when its government pumped in a US$586bil (RM1,828bil) stimulus package in response to the subprime crisis.

All this excess liquidity has, however, causing a housing bubble and also saved a number of underperforming Chinese state-owned enterprises from having to reform.

At the same time, Chinese policymakers were debating long-standing calls for them to cool down their economy – a fateful decision as we will see later.

As the astute Henny Sender wrote in the Financial Times on July 11, the investment products which form the backbone of Chinese “shadow banking” have the potential to create yet another subprime crisis.

Why? Well, many of China’s hedge funds are shorting the shares of China’s weaker banks. Does that sound familiar?

According to Sender: “… second-tier banks listed in Hong Kong or in mainland China, including China Merchants, China Minsheng Banking and tiny Huaxia, are vulnerable” as they “… have less ability to absorb losses and more of their balance sheets are tied up with shadow-like activities.”

Minsheng, founded in 1996, is China’s ninth-largest bank by assets and the only private bank amongst its top 10 commercial lenders.

It also, according to JP Morgan, has the fastest growth in inter-bank assets and the highest weighting of interbank liabilities to total interest bearing liabilities.

As mentioned, China’s government was initially determined to “cool” its economy.

The People’s Bank of China (PBOC) hence refused to intervene when the Shanghai interbank offered rate (“Shibor”, China’s LIBOR) spiked to an all-time high, to almost 14% from 3% previously.

This led to fears that the sudden “credit crunch” would leave banks like Minsheng at risk of default, the very thing that caused the collapse of Western banks like Lehman in 2008 due to a sudden lack of liquidity.

Indeed, in late June worried investors sent Minsheng’s shares down by 16.7%, wiping out US$6bil (RM18.7bil) of its market value.

Talk of a crisis forced the PBOC to promise to end the credit crunch.

Still, worries over China’s shadow banking system persist.

As Fitch Ratings has stressed, systemic risk over China’s mid-tier banks is rising due to their credit exposure and weakness in absorbing losses.

It remains to be seen whether banks like Minsheng will indeed become China’s Lehman.

But this much is clear: those who ignore history are doomed to repeat it.

Ceritalah  By KARIM RASLAN

Related posts:

Asian banks remain to be seen more scandals will surface 
'The year of shame 2012' get any worse in 2013?

For the sake of money people will risk anything

Singapore's investigation into banks was triggered by the Libor-rigging scandal last year. 

HOT on the heels of the London interbank offered rate (Libor) rigging scandal comes the Singapore interbank offered rate (Sibor), the Singapore equivalent of the Libor rigging.

HSBC, Standard Chartered, JP Morgan Chase, Barclays and DBS are among 20 banks in which 133 traders tried to manipulate the Sibor, swap offered rates and currency benchmarks in the city-state, the Monetary Authority of Singapore (MAS) said in a statement recently.

For the sake of money, people will risk anything. In this case, Singapore is well known as a tough regulator, but they still dare to mess around with the Sibor. They are definitely asking for trouble.

According to South China Morning Post, MAS has censured banks for trying to rig benchmark interest rates and ordered them to set aside about S$12bil (RM30.13bil) at zero interest, pending measures to improve internal controls.

It is surprising that these traders have been caught with their pants down.

Regulators have cracked down on market players following the Libor rigging fiasco, which involved Barclays, UBS and the Royal Bank of Scotland paying fines of up to US$2.5bil (RM7.89bil).

This is why even when news emerged on punitive measures for the Libor rigging, very few people believed in its effectiveness.

MAS said it would make rigging key rates a criminal offence and bring supervision under its oversight.

To put this into process may take some time, while these market players exploit any loophole or weaknesses.

The fact that Asian banks are also involved in this Sibor rigging makes it even more unpalatable.

So far, Asian banks have remained strong amidst the financial crisis. Their reputation has remained largely untarnished, although most have been quite silent on their risk management.

Many of their Western counterparts have had to shed jobs massively and close down or downsize businesses, with some even having to accept taxpayers' money to survive.

At the same time, banks in the West became embroiled in the blame game, came under heavy fire from regulators and some even had to undergo a serious revamp of their business model.

Among the positive things happening among Asian banks is the recruitment of talent at a time of major job cuts in the Western banking sector.

But even that little positive aspect is going to be drowned by accusations of the Sibor rigging.

Manipulation of interest rates is a serious offence. Resulting from such collusion, some disruption may be seen in market movements, which may give rise to uncertainties.

Plain Speaking - By Yap Leng Kuen

Columnist Yap Leng Kuen reckons it is not always true that once bitten, twice shy.

Related posts:
'The year of shame 2012' get any worse in 2013? 
The Libor fuss!
HSBC Bank fined $1.92 billion for money laundering
The rotten heart of capitalism: interest rate-fixing 

Bank losses worrisome !

It is imperative for banks to have a better prediction of their losses so that their capital position will be better reflected

IT may seem strange to analyse bank losses at a time when major banks, even the taxpayer-owned ones, are profitable.

Moreover, major economies are also said to be turning around. So why would we be so worried about bank losses?

According the analysts at Barclays, this is related to the bank's risk-weighted assets.

With so much focus on capital and the need to boost capital for the taxpayer-owned banks, it is inevitable that the question on losses would pop up.

That's when the banks accurately forecast the capital required.

However, if they do not have a fairly accurate idea of the losses they may be incurring, they may not be allocating enough capital buffer for it.

Therefore, the analysis on bank losses should be seen in a positive light as it helps to shed information early on the capital position of the bank.

The startling fact is that the banks themselves may not be able to predict their losses with a fair degree of accuracy, said the Telegraph.

UK, European and Asian banks, on average, forecast losses of nearly 30% higher than those they actually faced, the survey by analysts at Barclays found.

According to the report, Lloyds and HSBC predicted a default rate on their lending portfolios more than 50% above what they actually experienced.

Barclays was found to have been too pessimistic, particularly with assets in its investment bank where it forecast a default rate 78% higher than in reality.

“Most of the time banks' PDs (predicted defaults) are lower than forecast, suggesting a degree of conservatism,” the analysts said, as quoted by the Telegraph.

“The forecasting errors' can be massive, which raises questions over both their predictability and hence meaningfulness of the resulting risk weighted assets,'' they said.

It is therefore imperative for banks to have a better prediction of their losses so that their capital position will be better reflected.

Banks' boards of directors are fortifying themselves with new knowledge.

HSBC, the largest British bank, has appointed former director-general of British Security Service, Sir Jonathan Evans, onto its board, with expertise in counter terrorism and cyber threats.

With the accusations of money laundering, these major banks are coughing up a lot of money to engage top guns that can deal with the intricacies of it all.

Before terrorim, it was risk posed by over dabbling in derivatives. Banks engaged armies of risk and compliance oficers

Whether these counterrorism and cyber threat themes really emerge into trends remains to be seen.

A survey by pension fund The Scottish Widow indicated that in 10 years' time, Britons will have to work till 70.

They do not have enough savings to last through, as they are currently caught up in daily living expenses, it was reported in The Guardian.

That sounds chilling but fast becomig a reality soon in many other countries.

Many will start rushing for health and pharmaceutical products to strengthen themselves while others will just struggle on.

Plain Speaking by YAP LENG KUEN

>Columnist Yap Leng Kuen reckons it's easier to think positive.

Related:

UK taxpayer-owned banks take harder hit

Currency Wars: the Unloved Dollar Standard from Bretton Woods to the Rise of China

A yen for the unloved dollar standard

Tan Sri Andrew Sheng gives analyses the populist and expert views of how the yen measures against the “unloved US dollar standard”.

TRAVELLING around the South-East Asian region last week, the mood was all about currency fluctuation and impact on markets.

Things do look different when the Thai stock market daily turnover touches US$2bil and is higher than that of Singapore. But the headline that Thai growth slowed quarter-on-quarter but still grew 5.3% year-on-year gave rise to fears that export-driven economies in the region are beginning to slow.

The guru on the dollar relationship with the East Asian currencies has to be Stanford Professor Ronald I. McKinnon. McKinnon made his name with his first book, Money and Capital in Economic Development (1973), where he took forward the pioneering work of his Stanford colleague, Edward S. Shaw on the phenomenom of “financial repression” the use of negative real interest rates as a tax to finance development. His second book, The Order of Economic Liberalization: Financial Control in the Transition to a Market Economy (1993), was an influential textbook on how to get the sequencing of financial and trade reform right.

McKinnon's second area of expertise is the international currency order, explaining the macro-economics of the US dollar and its relationship with other currencies, particularly the yen and other East Asian currencies. The trouble was that his analysis did not “jive” with the populist policy view that “revaluing the other currency” would reduce the US trade deficit.

This began with the concern in the 1970s that the US-Japan trade imbalance was due to the cheap yen relative to the dollar. The Plaza Accord in 1985 was the political agreement to strengthen the yen and depreciate the dollar. From 1985 to 1990, the yen appreciated from 240 yen to 120 yen per dollar, followed by a huge bubble and two lost decades of growth.

In his important new book, McKinnon explains some uncomfortable truths with regard to what he called The Unloved Dollar Standard: From Bretton Woods to the Rise of China, Oxford University Press. The dollar standard is unloved because of what one US Treasury Secretary told his foreign critics of US exchange rate policy “our dollar, your problem”.

McKinnon argues that US monetary policy has been highly insular, despite globalisation making such insularity obsolete. He thinks that three macroeconomic fallacies were responsible the Phillips Curve Fallacy; the Efficient Market Fallacy and the Exchange Rate and Trade Balance Fallacy. In the 1960s, the US belief in the Phillips Curve that higher inflation generated lower unemployment resulted in the US pushing the Europeans and the Japanese to appreciate their currencies. When they refused, Nixon broke the link with gold in 1971.

In the Greenspan era (1987-2008), there was a strong belief in Efficient Markets, which encouraged global foreign exchange liberalisation, despite high volatility. But the most enduring fallacy is the belief that the exchange rate's role is to correct trade imbalance, hence the Japan bashing in the 1980s and the China bashing in the 21st century in order to push for their exchange rates to appreciate in order to reduce the US trade deficit.

McKinnon considers the third fallacy as the most pernicious conceptual barrier to a more internationalist and stable US monetary policy. Chapter 7, which is written by his student Helen Qiao, gives a robust argument why the third fallacy is wrong. She argues that while a depreciation of an insular economy with no net foreign liability may result in improved trade balance, it is not clear whether the depreciation of the dollar with a large net global liability is to the benefit of the United States.

In the case of Japan, a rising yen since the 1970s did not “cure” the Japanese trade surplus with the US. Between 2005 to 2007, when the yuan appreciated, the Sino-US trade surplus doubled. Qiao worries that China could follow Japan's steps into deflation and even a zero-interest rate liquidity trap if the yuan continues to appreciate.

The central thesis of this book is that the US should recognise that the dollar standard is actually a global standard, with many privileges and responsibilities. Depreciating the dollar is not to the US advantage, because it would only lead to future inflation. Instead, the US should concentrate on improving its competitiveness and manufacturing prowess. This requires having positive real interest rates.

The logic of the McKinnon thesis is irrefutable, although his American colleagues may find the conclusions somewhat unpalatable. The logic is that whoever maintains the dominant currency standard must maintain strong self-discipline, because the benchmark standard cannot be on shifting sands. If the dollar is weak because the US economy is weak, then all other currencies will be volatile, because they float around an unsteady standard.

For small open economies that maintain large trade with the US, having dollar pegs require them to keep their economies flexible and they must maintain fiscal and monetary discipline. This is the experience of the Hong Kong dollar peg.

Flexible exchange rates have not resulted in countries adjusting their overall competitiveness. What happened instead is that flexible exchange rates often allow governments to run “soft budget constraints” and try to depreciate their way out of the lack of competitiveness.

It is the refusal to make structural reforms that cause overall competitiveness to decline and these economies then go into a vicious circle of over-reliance on the exchange rate to keep the economy afloat. This is not sustainable, since if everyone tries to devalue their way out of trouble, rather than making structural adjustments, then the world will enter into a collective deflation.

The solution to this requires the US and China to work cooperatively at the monetary and exchange rate levels. This makes a lot of sense, which is why perhaps presidents Barack Obama and Xi Jinping are meeting soon to achieve rapport.

Anyone who wants to understand currency wars must read this book. It is an honest and frank appraisal of how we need common sense to get out of the current fragile state of global currency arrangements.

THINK ASIAN By TAN SRI ANDREW SHENG
■ Tan Sri Andrew Sheng is president of the Fung Global Institute.

Online banking Trojans going after your money!

Online banking users in Malaysia need to be wary of sophisticated Trojans. 

IMAGINE a burglar hiding in your house and slowly cleaning out your valuables, bit by bit, without you even realising it.

According to security firm Symantec, that is the common modus operandi of banking Trojans today, which have grown so sophisticated that they are almost impossible to detect and very difficult to get rid of.

As its latest white paper the World of Financial Trojans reveals recently, malware (short for malicious software) attacked over 600 financial institutions worldwide last year.

With this growth, bank hold-ups or ATM robberies, the bank heist of choice in Malaysia these days will soon be a thing of the past.

The phenomenon is no doubt partly due to the growing trend of online banking. As banks move online to make their transactions fast, easy and convenient for customers, cyber criminals are also finding the digital route the faster, easier and more convenient mode for looting.

A big threat, the report highlights, is the rate at which banking Trojans are now developed: with state-of-the-art mechanisms to circumvent the more complex security systems and exploit their weaknesses.

“Trojans have indeed evolved and the attackers have become more specialised and sophisticated,” Symantec Corporation (Malaysia) Sdn Bhd director (systems engineering) Nigel Tan concurs.

Most worrying, is that while the United States and Japan remain top of their target list, the banking Trojans are increasingly targeting emerging economies with high Gross Domestic Products (GDP) in Asia and the Middle East like Malaysia.

Tan notes, “Malaysia is on the radar of these cyber criminals and our financial institutions experienced attacks out of the 600 reported globally last year. We are not in the top 10 of countries attacked but the threat for Malaysia is no less dangerous.”

Internet banking has grown steadily in Malaysia since it was first launched in June 2000, and is now offered by 29 banks in Malaysia. As of September last year, there were 12.8 million registered users, rising from 3.2 million in 2006 and eight million in 2009.

Predictably, cyber crimes in Malaysia have also increased, with some RM2.75bil losses recorded over five years, from 2005 to 2010, especially in the financial sector.

The fact that cyber criminals are starting to eye Malaysian banks means we need to be more vigilant and tighten up our cyber security, says Tan.

End-users need to keep abreast with what security measures there are. - Nigel Tan

“They need to look at the malware threats they are risked to and look for measures to mitigate them because any organisation will face these threats.”

However, one problem is that many of these institutions cannot keep up with the constantly evolving sophisticated attacks. Another is the gap in the ability of certain organisations to detect threats on customers systems, according to the report.

Tan concedes that the security of our financial institutions can be improved.

Another challenge is that the Trojans are beginning to work out which banks have less security, and going after them, he warns.

“There is a difference in quality between the different banks in terms of how much of the protection and fraud detection methods they put in place.

“And if you are a robber trying to decide between two houses one big house with full security or one smaller house with minimal security; it is secured with only a padlock and chain which one will you target?” Tan quizzes.

As the report sums it, banking Trojans now “enter through the backdoor, strike with clinical precision, and have evolved to a degree of sophistication that allows attackers to conduct high-value transactions while evading traditional fraud-detection measures.”

It is not that banks have been unaware of this growing threat. Since online banking was first introduced in 1994, cyber criminals have looked for various ways to attack them. By 2003, around 20 distinct banking Trojans have existed including simple keylogging Trojans and phishing, said the report.

In response, the banks bolstered their security and fraud detection capabilities.

The problem is, the cyber criminals started adapting, until most security systems and measures were neutralised.

Tan calls these cyber criminals a specialised hacking community that is no longer searching for notoriety and fame, but is in it for the money.

“Hackers now are less noisy than five years ago, but just because there is less noise right now, it does not mean that they are not there. Trojans now stay in your computer as quiet and as long as possible to steal as much money as possible,” Tan cautions.

As mentioned, an attack technique increasingly used is called “man-in-the-browser” which basically involves an application hooking into the browser and manipulating data before it is displayed.

Sophisticated thievery

The report explains, the users will not be able to detect any malicious activity but the Trojan will intercept their transactions and inject a form in the browser requesting sensitive information. Once the user submits the requested personal information, it steals the data for future thievery.

The more sophisticated Trojans can automatically execute transactions in the background, the report highlighted.

What makes it difficult to notice with the naked eye, says Tan, is that “the domain is legitimate and the security page is accurate. It is your computer that is affected, so it can steal your personal data or attack your bank.”

One thing that makes it difficult to clamp down on the attackers behind these Trojans is that it is not easy to pin the crime on them.

“Just writing malware is not an offence. It is hard to pin it as a crime, as long as the writer does not go out and sell it,” Tan points out.

It also does not help that they are reportedly organised underground groups who are not only experts at scripting and automating attacks, but are also knowledgeable about the sophisticated global financial industry and supported by a service industry of widely available malware.

It is akin to organised crime, he opines.

As the report puts it, “The financial fraud marketplace is also increasingly organised. It is a service industry where a wide variety of financial Trojans, webinjects, and distribution channels are bought and sold. Services being offered are dedicated to each aspect of a financial fraud campaign. These offerings will improve effectiveness of established techniques.”

The Top Three of the “Most Wanted” malware list in 2012 were the Zeus Trojan, also known as Zbot (+ Gameover), having compromised more than 400,000 computers worldwide; followed by Cridex at more than 250,000 computers compromised and Spyeye at more than 50,000.

Symantec also points to third-party remote webinjects which can circumvent security countermeasures, targeting a large number of financial companies “concurrently and intelligently” as posing a threat to financial companies.

According to the report, it is not only the main financial organisations like commercial banks that are high on the list of targets, but also organisations that perform online financial transactions such as automated clearing house payments systems and payroll systems.

It is thus crucial for the “good guys” to be alert all the time. They can't slip up and must put in place adequate security mechanisms and take strong measures to deter attackers from targeting these institutions, Tan urges.

Ultimately, users cannot leave the responsibility for security solely to the institutions, he warns.

“End-users need to raise their awareness of the threats out there as at the end of the day, the criminal will go through the end-user to attack the financial institutions.”

The best measure, he stresses, is not to get infected in the first place, so installing a good anti-malware programme on your personal devices is crucial.

As he puts it, anti-malware solutions can stop the malware, even if you were already infected, shares Tan.

“The scanning will pick it up and delete it off your system.”

Tan also emphasises ongoing education in security, as the threats are constantly evolving.

“There will not be a point where you can say this is it. This is what everyone should do. End-users need to keep abreast with what security measures there are.”

Good practice needs to be adopted such as reading the message box or running an anti-virus before downloading anything from a website.

“Most of the time when people get a pop-up to say that you have a malware, they just cancel it or click it close, or when it says your computer is infected, they just ignore it.”

Significantly, Tan says this is not a call to say that Internet banking is bad.

“Quite the contrary. Internet banking has a lot of benefits.

“But as we embrace any new technology or media, we just have to be aware of what the threats are on the Internet. As long as we take adequate protection, we will be safe.”

By HARIATI AZIZAN sunday@thestar.com.my

Making monkeys out of markets

IT'S now official. Even monkeys can beat the stock market index. Cass Business School researchers in London simulated 10 million portfolios of US stocks selected at random. They found that a US$100 invested at the beginning of 1968 would have yielded US$5,000 by the end of 2011, but half the monkey (computer-simulated) portfolios managed US$8,700, one quarter made more than US$9,100 and 10% made more than US$9,500.

So, does the market beat all the professionals if monkeys beat the market?

There is a real lesson here for investors. I had a great debate with a good friend last month regarding the benefits of investing in a world where fast trading algorithms (using super fast computers to detect market opportunities to buy, sell or short stocks make it hard even for traditional asset managers to compete. So what chance is there for retail investors? My friend decided to get out of trading stocks.

Investing has been such complicated business because there are just too many variables to handle. Gone are the days when you think you can understand how markets perform. The rules of the game changed when policymakers began intervening through unconventional monetary policy and politics become part of the equation.

You would have thought logically that growth economies should produce growth stocks. The BRICS economies (Brazil, Russia, India, China and South Africa) met in Durban at the end of March. These five countries accounted for over half of total global growth since 2001, but their stock markets have not done that well. Since its peak in 2007, the BRICS index is down 37%.

Chinese retail investors have declined in number, based on the number of accounts closed. The A share index is down 31% since its peak in 2009, and the Brazil, Russia, India and South Africa stock market indices are all in negative territory since the beginning of this year. On the other hand, both the US and Japan are sluggish in growth and their stock markets performed 11.1% and 20% respectively since the beginning of this year.

Despite being overall in crisis and negative growth, even the European stock market performed in positive territory, mainly due to better performance in Germany and France. There are globally diversified companies in these economies that can outperform despite the slowdown in the European economy.

The real problem is that negative real interest rates around the world are truly destroying the ability of investors to judge what is the right asset to invest in. Markets are clearly bubbly when emerging market investors start investing in taxi licenses.

Accordingly to a Bloomberg report, Turkish taxi licenses today trade for US$580,000 each. My Hong Kong taxi driver was complaining to me that a Hong Kong taxi license was trading over HK$7mil (just under US$900,000) and yielding next to nothing.

It made no sense to him as a taxi driver himself to be an owner. This reminded me that in 1996, golf club membership was being touted as the best investment ever, with the 1997 Asian financial crisis wiping out all gains thereafter.

So what should an honest, no-inside information retail investor do? I guess the old-fashioned advice to invest in diversified and value stocks and maintaining ample liquidity is still sound. Global bonds have done well since the financial crisis due to the massive quantitative easing.

Even those who have speculated on Greek bonds when they were yielding more than 20% have done well. But it is difficult to argue that ten year US Treasuries and German Bunds at under 2% per annum represent no risk. Certainly, Japanese 10 year bonds at 0.55% per annum, when the official inflation target is 2% per annum, must carry considerable interest rate risks.

Over the long-term, there is no question that investing in one's own home has been good investment. This is officially supported leveraged investment, since most mortgages still require not more than 30% down payment for the first home. The fact that there is a growing middle-class in most emerging Asia means that demand for housing is still on the increase, but given such low interest rates, it is hard to imagine how much further can house prices rise relative to the affordability index.

My own inclination is to go for high yield, solid growth companies that are globally diversified. You basically invested in the region that you are most familiar with, and in companies that demonstrate good governance and know what they are doing. The average price/earnings ratio of Hong Kong, Singapore, Malaysia and Thailand markets are still below those of the US (17.7). China A share has a PE ratio of only 8.1 and a yield of 3.7%.

Of course, the art of investing depends completely on the investor's risk appetite, age and liquidity requirements. If you are fully invested in illiquid assets or in illiquid markets, you cannot get out even though the returns look good. Property markets are notoriously easy to get into and difficult to cash out, especially in the smaller markets. Bond investments may look good on paper, but when you want to exit, the selling price may be lower than what you think you can get, especially for retail investors.

Knowing that even monkeys can beat the market gives one food for thought. You can do better, but you must invest the time and energy to think through what you are investing in, what risk you are taking and what you want to achieve. My friend in Australia had no formal training in investments, decided that she could outperform the market, relied on her instinct and own research into companies and is now doing pretty well on her own.

Even monkeys know how to survive, so don't look down on monkeys.

THINK ASIAN By TAN SRI ANDREW SHENG

■ Tan Sri Andrew Sheng is president of the Fung Global Institute. He was recently named by Time magazine as one of 100 most influential people in the world.

Related posts:
Financial crises a result of governance failures 
: Who invented bank deposit insurance? 
New economic thinking 
The year of shame 2012' get any worse in 2013? 
The rotten heart of capitalism: interest rate-fixing   

Views by market research analysts, would the Snake bite 2013?

The 12-year zodiac has turned from the last year dragon to Snake 2013. Would the snake bite as the snake's reputation might be? Remember 2001 was the year of the 9/11!

Welcome to Year of the Water Snake! Snake is the Yin to last year's Dragon Yang. That said, Snake does not settle for mediocrity, either. We're likely to see significant developments in the area of science and technology this year. Research and development are apt to flourish. This is a Water year as well, the element most closely associated with education and research, making 2013 a very special year for scientists and scholars. Snake is a great sign, a positive one, with energy that can help us face all of the challenges ahead of us. Let's take advantage of this vibrant influence to improve our lives -- and our world!

THE world markets have always been a subject of focus whenever a brand new year comes a-calling.

Will they perform well or are investors in for a tough time?

As usual, while some have looked to the study of feng shui to predict how markets will perform and react in this Year of the Water Snake, a few analysts and fund managers have mostly chosen to stick to regular facts and figures when giving their opinions.

Here are the views of some of them randomly selected by StarBizWeek.
VINCENT KHOO
Head of research
UOBKayHian Research

Do you believe in using feng shui to predict market movements?

For fundamental research, we do not take feng shui into consideration

What are your top picks in the Year of the Snake? Why?

The over-riding investment theme for the year's market is laggards. Market laggards dominate our “buy” list.

We also advocate three categories of stocks to focus on for timing purposes. These are stocks which are immediate “buys” such as high-yielding stocks including number forecast operators and construction stocks, noting that positive newsflows are already emerging, stocks to accumulate on slight weakness such as telecommunication stocks, and stocks to accumulate on deeper retreats, such as the perceived politically-linked stocks which feature exciting growth prospects

Our contrarian view includes being overweight on construction stocks.

What are some of your “predictions” for financial markets this year?

The local market has predictably fallen after a short year-start rally. We expect a significant retreat in small-mid caps after an impressive January-Effect' rally. We also expect market to dip further before elections, but downside is limited, and it should recover significantly thereafter.

THOMAS YONG
Chief executive officer
Fortress Capital Asset Management (M) Sdn Bhd

Do you believe in using feng shui to predict market movements?

We don't use feng shui in our work.

What are your top picks in the Year of the Snake? Why?

In Malaysia, our top picks are UMW Holdings Bhd and CIMB Group Holdings Bhd. Despite a return of 70% in the year of 2012, we think that the prospects for UMW continue to remain bright.

The automotive division has been performing well as its Toyota brand continues to gain market share, while the Perodua brand dominates the budget segment.

Earnings contribution from the oil and gas division has improved vastly and the earnings momentum is likely to pick up in coming years, buoyed by the potential of raising funds via an initial public offering.

In the near-term, weakening of the US dollar and Japanese yen arising from quantitative easing would also be favourable to UMW Holdings.

CIMB Holdings has been delivering consistent earnings but its share price has under-performed the market, due to political concerns in Malaysia.

The group actually derives about 40% of earnings outside Malaysia and the overseas earnings contribution is expected to increase further with the strategic regional expansion.

Besides positive enhancement of the CIMB brand, its recent acquisition of Royal Bank of Scotland investment banking operations has also provided CIMB Group with an established platform to compete internationally.

Notwithstanding the solid fundamentals of the two stocks, one need to be cautious in determining the entry level for the stocks in light of the recent market volatility on the back of election politics.

What are some of your “predictions” for financial markets this year?

As the US and Japan are expected to continue with quantitative easing, we expect interest rates to stay low for the year 2013, stoking asset inflation.

While alternative investment such as property has traditionally proven to be a good asset inflation play, the sector will likely face continued policy curbs.

Taken with sight of economy recovery led by China and the United States, we believe equity as an asset class provides a very attractive risk return potential.

HWANGDBS VICKERS RESEARCH
MALAYSIAN RESEARCH TEAM

Do you believe in using feng shui to predict market movements?

Feng shui is just an additional tool used to make certain predictions.

Our bread-and-butter research approach has always been fundamental analysis supported by technical analysis.

What are your top picks in the Year of the Snake? Why?

Against a turbulent market backdrop, the benchmark FBM KLCI could swing between 1,500 and 1,750 going forward, and probably settle at our fundamentally-driven end-2013 target of 1,690 (based on one-year forward P/E of 14 times.

Hence, investors should view any market dips as buying opportunities to ride on the subsequent recoveries.

The Year of the Snake may bring good luck to industries linked to earth, metal and water elements, such as property, construction, petroleum and banking.

By being defensive, investors are expected to flock to sectors or stocks that generate strong operating cash flows and pay appealing dividend yields such as Pos Malaysia, Maybank and KLCC Property, to name a few.

What are some of your “predictions” for financial markets this year?

On the global economic front, we should see continuous gradual recovery supported by an underlying positive mood.

The recurrence of an economic fallout in the United States or a financial blow out in eurozone can happen, which can then force a downward spiral in investors' confidence.

KALADHER GOVINDAN
TA Securities
Head of research

Do you believe in using fengshui beliefs to predict market movements?

I wish predicting market behaviour could be that easy. Feng shui or even the much older Indian version, Vastu, for that matter gives you a “common sense” perspective on how certain things should be done in harmony with nature to reap the maximum benefits for health and well being but it is not a single criterion that binds everything for success or wealth.

What are your top picks in the Year of the Snake? Why?

Sell-on-strength, especially overvalued defensive plays in the consumer, healthcare and telco sectors, and turn cash-heavy to accumulate high beta plays in domestic sectors, which are mainly related to construction, oil and gas and property sectors, in the first half of 20 13. The banking sector holds good buys based on their attractive valuation, still robust loan growth and bright chances of benefiting from ongoing domestic expansion .

What are some of your “predictions” for financial markets this year?

Issues in Europe will last longer. The structural flaws cannot be undone overnight but expect bouts of positive improvements to kick in the second half of 2 013 as fats are trimmed and jobs created. China could revive its domestic growth without stoking inflationary pressure but it can be a destabilising factor if its row with Japan escalates. The same applies to Iran and the West.

LIM TECK SENG
Deputy managing director
JF Apex Securities Bhd

Do you believe in using feng shui to predict market movements?

Not at all.

What are your top picks in the Year of the Snake? Why?

I prefer good value penny stocks because the capital appreciation of these stocks are much faster and larger, compared to bigger-cap stocks. Stocks are all about packaging, style and branding.

What are some of your “predictions” for financial markets this year?

Financial markets revolve around banking, wealth management and the economy.

It has nothing much to do with stock markets. The stock market is all about liquidity and cashflow.

If there is enough liquidity, cashflow and interest in the stock, the stock will run. Liquidity is the most crucial component to the stock market.

EDMUND THAM
Head of Research
Mercury Securities

Do you believe in using feng shui to predict market movements?

Some people may use it, but I personally do not use feng shui to predict the market.

What are your top picks in the Year of the Snake? Why?

Currently I'm looking at property and crude palm oil (CPO) stocks, for both value and dividend yield.

The prices of quite a number of them have come down recently. However, they have the potential to “come back” later in the year. CPO stocks would probably only come back later in the year if and when CPO prices recover.

Property players with projects in prime areas locally (Penang island, Klang Valley, Iskandar Region) and overseas stand to perform well.

CPO picks - IOI Corp Bhd, TDM Bhd, TH Plantations Bhd, Hap Seng Plantations Holdings Bhd.
Property picks - Glomac Bhd, Mah Sing Group Bhd, SP Setia Bhd, UOA Development Bhd.

What are some of your “predictions” for financial markets this year?

For the local market, less volatility could lead to a higher KLCI level, especially in the first half of 2013.

The cautious investor sentiment due to GE13 is likely to suppress market participation for Q1 and maybe Q2.

The Dow Jones is at quite a lofty level, and we're not sure if it can be sustained above the 14,000 points level.

By YVONNE TAN yvonne@thestar.com.my 

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Malaysian banks optimise depposit rates and lending

PETALING JAYA: Competition for fixed deposits (FDs) is set to continue as banks eye new liquidity by offering better interest rates to depositors following the postponement of the Basel III liquidity requirement rules. Industry analysts said banks would also likely optimise their lending ability moving forward.

Ambrose: ‘Malaysia has a well-functioning banking system while Europe does not and the US barely does.’

“It's not good to be too conservative in lending. It is important for the overall economic wellbeing of the country and it gives life to businesses, bringing prosperity to the country,” said a banking analyst from one of the four largest local banks by asset size.

According to Gerald Ambrose, the managing director of fund management company Aberdeen Asset Management Sdn Bhd, the stricter Basel III requirements to ensure banks are well capitalised may not be too suitable for Malaysia which presently has a well-functioning banking system.

“Malaysia has a well-functioning banking system while Europe does not and the US barely does. I think capital requirements that are too strict may potentially stifle economic activities,” Ambrose told StarBiz over the telephone recently.

Commenting on recent banking statistics, RHB Research in a recent note said the November 2012 system statistics showed loans growth had eased to 11.2% year-on-year (y-o-y) from 11.8% y-o-y growth in October 2012.

“The slower pace of growth was attributed to higher repayments during the month, partly mitigated by stronger disbursements. Meanwhile, household loans continued to expand at a steady pace of 11.6% yoy,” RHB Research analyst David Chong said in the report.

Chong noted Nov 2012's total system deposits grew 11.3% yoy with this growth being broad based' with loans to deposit ratio unchanged month-on-month (m-o-m) at 81.6%, the system core capital ratio was at 13.4% and risk-weighted capital ratio stood unchanged m-o-m at 15.3%.

According to Alliance Research banking analyst Cheah King Yoong, these statistics showed the domestic banking system remained “well capitalised” and “resilient to withstand unanticipated shocks to the financial system, if any.”

Cheah added that lending activities did not pick up towards the end of 2012 which could be due to both lenders and borrowers turning cautious with the impending general election which is widely expected to be held in March.

“We reiterate that there could be two potential de-rating catalysts, which pose downside risks to our 7-9% loan growth forecasts for 2013.

“These are (that) lending activities could decelerate in the first quarter of 2013 with slowing corporate loan disbursements and consumers turning cautious pending the upcoming general election,” Cheah said.

“Post-election, should the federal government implement (the) goods and services tax, resume its subsidies rationalisation programme and raise the electricity tariff to close its budget deficit; these fiscal tightening policies could have an adverse impact on consumer spending and consumer loans in the later part of 2013,” he added

By DANIEL KHOO danielkhoo@thestar.com.my

 

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• Time to put Basel III where it belongs.....#ecb #banks #spiral #stagnation #unemployment (simplesimon8.wordpress.com)

Who invented bank deposit insurance?

I LOVE the Internet. The best Christmas present I got last year was a preview of a forthcoming book by a banker/historian in Boston. He sent me electronically his PhD thesis, a piece of masterly detective work on how ideas travel over time and space, become adopted successfully in a different place, and then comes back to where they started.

Dr Frederic Grant Jr's forthcoming book uncovered how the US bank deposit insurance system has its root in ideas borrowed from Canton (Guangdong province in southern China) of the 19th century. The origins of the US deposit insurance scheme arose from the 1828 The Safety Fund statute of the State of New York, drafted by a legislator named Joshua Forman.

In those days, if the state-authorised banks failed, the state would have to pay for their failure. Forman borrowed the idea from Canton that those authorised for privileged trade (in banks the privilege of private currency issue) should be responsible for their own debts.

The success of the New York Safety Fund inspired the adoption of similar schemes by 13 other American states. In 1933, the Banking Act of 1933 created the Federal Deposit Insurance Corp (FDIC), following the failure of many banks across the US. This idea of a national deposit insurance scheme has been adopted by many countries around the world, and is currently being considered in China.

How did Forman get the idea about the Canton Guaranty Scheme? Apparently, New York was already the major port for US-China trade and the scheme was familiar to New York businessmen.

How the Canton system evolved

It all came about because the Qing dynasty official merchants, namely merchant houses (or hongs) authorised by Beijing to conduct foreign trade, often require trade credit to conduct business with foreigners in Canton. If these traders defaulted on their loans, the foreigners threatened to take action on the weak Qing dynasty. Hence, in order to prevent individual merchant failure, the Qing government used a collective responsibility method evolved by the Manchu court in Beijing that ensured that those authorised to benefit from the foreign trade also collectively guaranteed each other's trade debt, and a premium was paid yearly into a fund to pay off any individual failure.

The Qing government solved the problem of defaults by imposing collective responsibility everyone was responsible for the group's debt. The good news is that the group as a whole made sure that no member got into trouble, engaging in what is today called “peer surveillance”. The bad news is that with collective guarantee, the smaller traders have an incentive to take higher risks, creating moral hazard private gain at collective loss. Moreover, as history showed, if trade was really bad, more traders failed and since the Qing government also borrowed or taxed the accumulated fund regularly, there were not enough money in the fund to settle all debts. Eventually the Canton Guaranty Fund also failed.

Corruption and misappropriation of fund was to blame, but the main culprit remained what Grant called “the perennial dilemma of inadequate capital and lack of access to affordable credit” for smaller hongs.

These problems plagued all deposit insurance schemes, even today. Large banks loath to support deposit insurance because they pay a larger share of the premium than smaller banks. Small banks enjoy the group insurance, but are more prone to failure because they were more likely to take more risks, which meant that there should be supervision to make sure that these riskier players do not destroy the group as a whole.

Deposit insurance worked very well in the United States, as the FDIC not only participated in supervision of the insured banks, but also engaged actively as the mortuary of failed banks. In the recent crisis, from 2009 to currently, the FDIC smoothly managed the exit of over 400 banks in the United States, without disruption to the system as a whole. But this time round, it was the failure of the shadow banks and larger banks that created the problem. Yes, smaller banks failed, but they did not take down the whole system because deposit insurance prevented large-scale bank runs at the retail level.

The time has come for China to adopt a formal deposit insurance scheme. There are at least three good reasons why it should occur. The first is that deposit insurance will help stop retail bank panic, exactly the reason for the Canton Guaranty Fund. The second is that there must be an orderly exit mechanism for financial institution failure. Some argue that a deposit insurance would duplicate supervision. Today we realise why we have two kidneys instead of one we need redundancy in the system, in case one fails.

The third, based on my personal experience, is that regulators who are good at daily operations may not always be very good at conducting the messy operations of restructuring failed banks. This is a very complicated process that needs strong skills, good bankruptcy laws and more investment banking skills than regulation. Deposit insurance is specialised work and needs specialised skills.

As Grant rightly said, the historical record of the Canton Guaranty System offers a number of valuable lessons to the modern world. “These include (1) that the tax that supports a guaranty fund must be based on measured risk of loss; (2) that the fund and its insureds must be made subject to strong independent supervision; (3) that laws enacted to avoid risk contingencies must be enforced; and (4) that both corruption and the diversion of fund assets must be strictly prohibited.”

The trouble with history is that we never seem to learn from history.

THINK ASIAN
BY ANDREW SHENG

 > Tan Sri Andrew Sheng is president of the Fung Global Institute. 

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The rotten heart of capitalism: interest rate-fixing scandals

The magnitude of the banking scam must be realised and tough action taken

The UBS building in Zurich. Photograph: Michael Buholzer/Reuters



This is the year the consensus changed. Around the world, policy-makers, regulators and bankers recognised that the legacy of the 20-year credit boom up to 2008 is more corrosive than all but a few realised at the time. The bankers – and the theorists who justified their actions – made a millennial mistake. Navigating a way out of the mess was never likely to be easy, but it is made harder still by not recognising the magnitude of the disaster and the necessary radicalism involved if things are to be put right.

If there were any last doubts they were dispelled by the record $1.5bn fine paid by the Swiss bank UBS for "pervasive" and "epic" efforts to manipulate the benchmark rate of interest – Libor – at which the world's great banks lend to each other. The manipulation was at the behest of the traders who buy and sell "interest rate derivatives", whose price varies with Libor, so that cumulatively billions of pounds of profits could be made. Nor was UBS alone. What is now evident is that all the banks that made the daily market in global interest rates in 10 major currencies were doing the same to varying degrees.

There was a complete disdain for the banks' customers, for the notion of custodianship of other people's money, that was industry wide. It is hard to believe this culture has evaporated with the imposition of a fine. No banker falsifying the actual interest rates at which he or she was borrowing or lending, or trader who requested that they did so, had any sense that there is something sacred about banking – that the many billions flowing through their hands are not their own. It was just anonymous Monopoly money that gave them the opportunity to become very rich. The UBS emails, which will be used to support criminal charges, could hardly be more revealing. This was about making money from money for vast personal gain.

Interest rate derivatives are presented as highly useful if complex financial instruments – essentially bets on future interest rate movements – that allow the banks' customers better to manage the risks of unexpected movements in interest rates. Whether a multinational or a large pension fund, you can buy or sell a derivative so you will not be embarrassed if suddenly interest rates jump or fall. Bookmakers lay off bets. Interest rate derivatives allow buyers to lay off the risk that their expectations of interest rate movements might be wrong.

What makes your head reel is the size of this global market. World GDP is around $70tn. The market in interest rate derivatives is worth $310tn. The idea that this has grown to such a scale because of the demands of the real economy better to manage risk is absurd. And on top it has a curious feature. None of the banks that constitute the market ever loses money. All their divisions that trade interest rate derivatives on their own account report huge profits running into billions. Where does that profit come from?

The answer is it comes largely from you and me. Global banking, intertwined with the global financial services and asset-management industry, has emerged as a tax on the world economy, generating much activity and lending that has not been needed, but whose purpose is to make those who work in it very rich. The centre-left thinktank IPPR reports that people with identical skills earn on average 20% more in financial services than in other industries, with the premium rising the higher the seniority. That wage premium does not come from virtuous hard work or enterprise. It comes from how finance is structured to deliver excessive profit.

Scandalous

The Libor scam is an object lesson in how finance taxes the rest of the economy. Plainly, the final buyers of the mispriced interest rate derivatives could not have been other banks, otherwise they would have lost money and we know that they all made profits. In any case, they were part of the scam. The final buyers of the mispriced derivatives were their customers. Some must have been large companies, but many were those – ranging from insurance companies and pension funds to hedge funds – who manage our savings on our behalf.

Here a second scam kicks in. One of the puzzles of modern finance is why the returns to those who buy shares in public stock markets are so much lower than the profits made by the companies themselves. One of the answers is that there are so many brokers, asset managers and intermediaries along the way all taking a cut. Sometimes it is through excessive management fees, but another way is not doing honest to God investing – choosing a good company to invest in and sticking with it – but through churning people's portfolios or unnecessarily buying interest rate derivatives to protect against interest rate risk, while charging a fee for the "service". Many of those mispriced interest rate derivatives will have ended up in the investment portfolios of large insurance companies and pension funds or, more sinisterly, in the portfolios of the banks' clients.

Most rotten

Bank managements are presented as ignorant dolts, fooled by rogue traders. They were no such thing. The interest rate derivative market is many times the scale than is warranted by genuine demand precisely because it represented such an effective way of looting the rest of us. The business model of modern finance – banks trading on their own account in rigged derivative markets, skimming investment funds and manipulating interbank lending, all to underlend to innovative enterprise while overlending on a stunning scale to private equity and property – is not the result of a mistake. It represents a series of choices made over 30 years in which finance has progressively resisted any sense it has a duty of custodianship to its clients or wider responsibilities to the economy. It was capitalism allegedly at its purest. We now understand it was capitalism at its most rotten. It needs wholesale reform.

The government's proposals to ringfence investment banking from the rest of a bank's activities, following the proposals from Sir John Vickers, is a start. But it is only that. Last week, Conservative MP Andrew Tyrie's cross-party parliamentary commission proposed " electrifying" the ringfence with the threat of full separation if malpractice continues. It also considered banning banks from trading in derivatives on their own account. But while tough, the commission should extend its brief. The issue is to create a financial system in its entirety that serves individuals and business alike, makes normal profits and, above all, embeds its public duty of custodianship in the bedrock of what it does. The government fears that more upheaval will unsettle banking and business confidence. It could not be more wrong. Reform is the platform on which a genuine economic recovery will be built.

Comment by Will Hutton - Guardian
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