From the outside

This is possibly a bit self indulgent but “From The Outside” is fast approaching the 5th anniversary of its first post so I thought it was time to look back on the ground covered and more importantly what resonated with the people who read what I write.

The blog as originally conceived was intended to explore some big picture questions such as the ways in which banks are different from other companies and the implications this has for thinking about questions like their cost of equity, optimal capital structure, risk appetite, risk culture and the need for prudential regulation. The particular expertise (bias? perspective?) I brought to these questions was that of a bank capital manager, with some experience in the Internal Capital Adequacy Assessment Process (ICAAP) applicable to a large Australian bank and a familiarity with a range of associated issues such as risk measurement (credit, market, operational, interest rate etc), risk appetite, risk culture, funds transfer pricing and economic capital allocation.

Over the close to 5 years that the blog has been operational, something in excess of 200 posts have been published. The readership is pretty limited (196 followers in total) but hopefully that makes you feel special and part of a real in crowd of true believers in the importance of understanding the questions posed above. Page views have continued to grow year on year to reach 9,278 for 2022 with 5,531individual visits.

The most popular post was one titled “Milton Friedman’s doctrine of the social responsibility of business” in which I attempted to summarise Friedman’s famous essay “The Social Responsibility of Business is to Increase its Profits” first published in September 1970. I was of course familiar with Friedman’s doctrine but only second hand via reading what other people said he said and what they thought about their framing of his argument. You can judge for yourself, but my post attempts to simply summarise his doctrine with a minimum of my own commentary. It did not get as much attention but I also did a post flagging what I thought was a reasonably balanced assessment of the pros and cons of Friedman’s argument written by Luigi Zingales.

The second most popular post was one titled “How banks differ from other companies“. This post built on an earlier one titled “Are banks a special kind of company …” which attempted to respond to some of the contra arguments made by Anat Admati and Martin Hellwig. Both posts were based around three distinctive features that I argued make banks different and perhaps “special” …

• The way in which net new lending by banks can create new bank deposits which in turn are treated as a form of money in the financial system (i.e. one of the unique things banks do is create a form of money);
• The reality that a large bank cannot be allowed to fail in the conventional way (i.e. bankruptcy followed by reorganisation or liquidation) that other companies and even countries can (and frequently do); and
• The extent to which bank losses seem to follow a power law distribution and what this means for measuring the expected loss of a bank across the credit cycle.

The third most popular post was titled “What does the “economic perspective” add to can ICAAP“ and this to be frank this was a surprise. I honestly thought no one would read it but what do I know. The post was written in response to a report the European Central Bank (ECB) put out in August 2020 on ICAAP practices it had observed amongst the banks it supervised. What I found surprising in the ECB report was what seemed to me to be an over reliance on what economic capital models could contribute to the ICAAP.

It was not the ECB’s expectation that economic capital should play a role that bothered me but more a seeming lack of awareness of the limitations of these models in providing the kinds of insights the ECB was expecting to see more of and a lack of focus on the broader topic of radical uncertainty and how an ICAAP should respond to a world populated by unknown unknowns. It was pleasing that a related post I did on John Kay and Mervyn King’s book “Radical Uncertainty : Decision Making for an Unknowable Future” also figured highly in reader interest.

Over the past year I have strayed from my area of expertise to explore what is happening in the crypto world. None of my posts have achieved wide readership but that is perfectly OK because I am not a crypto expert. I have been fascinated however by the claims that crypto can and will disrupt the traditional banking model. I have attempted to remain open to the possibility that I am missing something but remain sceptical about the more radical claims the crypto true believers assert. There are a lot of fellow sceptics that I read but if I was going to recommend one article that offers a good overview of the crypto story to date it would be the one by Matt Levine published in the 31 October 2022 edition of Bloomberg Businessweek.

I am hoping to return to my bank capital roots in 2023 to explore the latest instalment of what it means for an Australian bank to be “Unquestionably Strong” but I fear that crypto will continue to feature as well.

Thank you to all who find the blog of interest – as always let me know what I missing.

Tony – From the Outside