August 24, 2015

In terms of capital requirements for banks, when travelling towards 20 or 30 percent, how do we survive the journey?

Sir, Jonathan Ford writes Alan Greenspan exhibited both candor and clarity in an article for the Financial Times in which he called for banks to raise substantially more capital “Higher capital is a less painful way to fix banks” August 26.

First, in that article Greenspan compared the evolution of traditional bank capital levels, with the much newer risk-weighted capital requirements concocted by the Basel Committee. They cannot be compared and so in doing Greenspan clearly evidence why he should take his retirement more serious, and better do like soldiers, just fade away.

And then, in terms of what capital requirements he has in mind, Greenspan writes about “20 or even 30 per cent of assets (instead of the recent levels of 10 to 11 per cent)”. Not mentioning whether he refers to risk-weighted assets or not, something which has implications not to be frowned at. For instance, with current risk weights of 100 percent when lending to unrated SMEs and entrepreneurs, banks could be required to hold 30 per cent in capital, while allowed to hold zero capital when lending to the zero risk weighted sovereigns… Is that what we need? And how do we get from here to there, without dying during the journey? Can you imagine the initial bank credit austerity that could ensue? 

Greenspan argued: “if history is any guide, a gradual rise in regulatory capital requirements as a percentage of assets (in the context of a continued stable rate of return on equity capital) will not suppress phased-in earnings since bank net income as a percentage of assets will be competitively pressed higher, as it has been in the past, just enough to offset the costs of higher equity requirements. Loan-to-deposit interest rate spreads will widen and/or non-interest earnings will increase.”

And I would just ask Greenspan: If you were thinking of buying bank shares… and heard about “a gradual rise in regulatory capital”, would you buy those shares now, or would you prefer to postpone that decision to when the increase in regulatory capital seems closer to being completed?