USA Finance - Taming The Banks
Thursday, September 23, 2010
The public's urge for revenge may not have been sated, but the new Basel rules make sense
TWO years ago the collapse of Lehman Brothers heralded a frightening period for the world economy. As one bank after another toppled, or came close to doing so, regulators worried that cashpoint machines would fail to operate and that companies would be unable to meet their payrolls. A second Great Depression seemed to beckon.
Extraordinary efforts were made to bail out the banks, including state guarantees, partial nationalisations, near-zero interest rates and massive fiscal deficits. The public seethed at the banks' profligacy. Surely finance would be reformed, as it was in the 1930s when America created a new regulator, the Securities and Exchange Commission, and separated casino-like investment banking from retail banking?
Two years on, the landscape of finance has altered somewhat. Take hedge funds: the crisis wiped out around a quarter of their assets and forced many mediocre ones out of business. Many private clients left in disgust when they found that these self-proclaimed superstars could lose money; the client base is increasingly dominated by institutions, which should insist on more transparency and better risk management. In private equity, the poor performance of the 2006-07 vintage of deals is making it harder for firms to raise money; one manager, Candover, is giving up the ghost.
But it is the banks that matter most; and, in banking, it is remarkable how little has changed. Many banks are still "too big to fail" and the casino side of their activities remains mixed up with the mundane business of deposit-taking. Bankers are once more earning huge bonuses. How could this be?
Breaking up the banks might have satisfied taxpayers' desire for revenge, but it is not clear what problems it would have solved. Anglo Irish Bank and Northern Rock collapsed not because they were too big, nor because they were playing the markets: they were classic "narrow" banks which failed in the traditional fashion--borrowing short to lend long against property that turned out to be overvalued. The problems of the Spanish cajas show that a financial system with lots of small banks is not necessarily safer.
Still, the crisis made it painfully clear that the world's banking system needed new international rules to impose lending discipline and guard against any temptation to migrate to the weakest regulatory regime. A new set, known as Basel 3, has been proposed (see "Financial regulation: Basel's buttress"). They will not satisfy radicals, but they will probably do the job.
The purpose of the new rules is to ensure that banks have more capital when they face the next crisis, and are thus better able to cope with bad debts. The core Tier 1 ratio will rise to 7%, slightly less than expected but still a lot better than before the crisis (at the end of 2007, Royal Bank of Scotland had a ratio of just 3.5%).
The timing is more questionable. The new requirements are being phased in slowly, under pressure from those countries, such as Germany, which escaped the worst of the crisis. The final deadline is not till 2019. Regulators reckon the rules are fairly tough but critics think this deadline is excessively generous. The fact that bank shares rose in response to the Basel announcement will add to cynics' suspicions that the banks have been given too much time.
For the moment, the system does not look dangerously undercapitalised. Most large, internationally active banks in America, Britain and Switzerland already meet the new requirements. As for other banks that don't, imposing higher capital ratios on them immediately might only discourage them from lending money to businesses, at a time when credit is already scarce.
More, please
The rules are sensible, so far as they go, but more needs to be done. In particular, it is vital that regulators deal with the "outliers", banks that lose more than average in a crisis. The best way to do that is to create a layer of debt that regulators can write off, or convert into equity, if necessary. National regulators should also firm up the rules on counter-cyclical capital, requiring banks to strengthen their balance-sheets during booms, rather than busts; this would help prevent a credit spree like that in 2005-06, and provide the banks with a cushion during a downturn. Extra rules may be needed for firms in the "too big to fail" category. And some banks need to reduce further their reliance on short-term borrowing.
These reforms will not turn the masters of the universe into model citizens overnight. Bankers circumvented the last lot of Basel rules, and regulators will have to watch out for attempts to do the same this time around. But higher capital requirements should eventually reduce the riskiness of banks, cut into their profit margins and constrain bonuses. The punishment may not seem commensurate to the crisis they caused; but reducing risk is more important than getting revenge.
A service of YellowBrix, Inc.
posted @ 1:39 PM,
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