August 30, 2013

An absolute capital requirement for a bank, expressed in pounds, euros or dollars, is not a good idea.

Sir, Martin Sandbu, holds that regulators should require and publicise absolute capital requirements for banks, not as a fixed equity ratio, but in terms of an absolute level of equity expressed in pounds, euros or dollars “to be reached regardless of how the balance sheet evolves over the review period”, “Ignore the bluster from banks over capital requirements”. August 30.

Except for as a temporary emergency measure, that sounds like a bad idea.

That would make it even more impossible than now for the market to know what the real capital requirement for the banks is; leading to that many who could be interested in being shareholders in a bank would postpone their decision to invest; meaning that would place our banking system into the hands of some regulator’s risk-models (1.6 percent capital when lending to Greece?); meaning the regulatory risk weighting that so distort bank credit allocation in the real economy would only have found another way of express itself; meaning that banks would, for political purposes, sooner or later, would be need to conform with being "a friendly bank".

But, since an absolute level of equity de facto operates as an equity ratio making risk-weighing irrelevant for the bank, for a while at least, much better would be to go for a one and the same equity ratio for all banks that makes prudential sense... in my opinion the 8 percent basic capital requirement of Basel II which was a good number… until it got so risk-weighted down.

Of course then you need to help and support the banks to reach those capital levels that for many banks now seems only like having to reach for the stars.