October 04, 2016

Regulators must now help banks escape the business model of capital minimization their distortive regulations created

Sir, Richard Blackden, while discussing European banks, writes: “Their return on equity (RoE) — a common measure of a lender’s performance — has been hit by regulators’ demands that they hold more capital.” “European banks still out in the cold” October 4. 

If banks had to hold the same amount of capital against any asset (as they de facto used to), then banks could do traditional banking, which was investing without distortions in the assets that offered them the highest risk adjusted margins.

Currently banks can’t do that because, with the risk weighted capital requirements, the risk adjusted margin of an asset, has now to be placed in perspective of how much capital is required against it. And so banks have become used to maximize their risk adjusted returns on equity, not so much by banking in the traditional sense, but by minimizing capital.

Of course just generally increasing capital requirements, while leaving a part of the risk weighting distortions in place, makes it much harder for the banks and the markets to understand and adjust to new realities.

Therefore, the faster regulators rid the banking sector of the risk weighting distortions, and impose one single capital requirements for all assets, the better for banks and, even more important, the better for the real economy.

I am sure investors would love to invest in banks that were made to operate and compete as banks in the traditional sense.

This world were you can now read about a bank’s common equity tier one ratio being for instance 10.8 per cent; something which could seem indicative of a leverage of less than 10 to 1; only to find out the real leverage could for example be over 30 to 1; and this only because some regulators wanted for him and you to have better information, is too damn confusing for any normal investor that could have wanted to have some bank shares, in his conservative portfolio.

@PerKurowski ©