October 03, 2018

Regulators, shareholders and clients, do not have a vested interest in banks holding little capital; only bankers do, because of their bonuses.

Sir, Sheila Bair discussing ongoing pressures in the US to reduce bank capital levels, especially for the big banks, correctly opines: “Tough capital rules are a competitive advantage, not weakness. Studies show that well-capitalised banks do a better job of lending than more leveraged rivals. Thick capital buffers keep the banking system functioning through economic cycles. Every dollar reduction in bank capital weakens the public’s protection against big failures.” “The US must hold firm on bank capital rules”, October 2.

That is the argument that should prevail and the more it is understood that those who mostly stand to win by low bank capital requirements, are just the bankers themselves, as the less equity there is a need to compensate, the higher can the bonuses be.

To that I would perhaps add what I wrote in an Op-Ed in 2001, “Today, when the world seems to be asking much for bank mergers or consolidations, I wonder if we on the contrary should be imposing on banks special reserves depending on their size. The bigger the bank is, the worse the fall, and the greater our need to avoid being hurt.”

In 2003, in a workshop for regulators at the World Bank I repeated, “Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. “

But what is sadly almost completely left out in the debate is that, no matter how high or how low the capital requirements are, different requirements, especially when like the current risk weighted ones do are based on risks perceived and mostly already cleared for, dangerous distortions in the allocation of credit to the real economy could result.

Again, for the umpteenth time risks, even if perfectly perceived, cause the wrong actions if excessively, or insufficiently considered.

In that respect my first recommendation on any bank regulation reform would be to get rid of the risk weighted capital requirements for banks. They stand out as one of the worse piece of regulations ever.

What was the 2007-08 crisis (and Greece’s tragedy) made off? Exclusively, 100%, by assets ex ante perceived (or decreed) as safe, and against which banks needed to hold especially little capital.