Banks with better capital will not stifle investment and growth. Bank capital requirements that are not neutral to perceived-risks will

Sir, I refer to David Miles, Professor of Financial Economics, Imperial College letter in which he argues that “Better capitalized banks will not stifle investment and growth” November 30.

He is of course right, but with some caveats.

First, it has to be reasonably well capitalized banks since, going overboard on capital requirements, might reduce the margins arising from leveraging and make getting that additional capital (equity) needed quite difficult.

Second, it is a delicate matter of how going from here to there. If you impose some drastic immediate adjustments then you must be prepared to go for instance the Chilean way, where its central bank made some important capital contributions but allowed former shareholders to repay them and buy them out when they could.

But, but, but! If you insist in that capital being risk weighted, it will just not work.

Suppose you want a 100% capitalized bank, but when calculating that 100% you keep on risk weighting the sovereign with 0%. That would mean that a bank would come up with 100% of equity if lending to a 100% risk weighted entrepreneur, but would be allowed to hold zero capital (equity) when lending to the sovereign. Would that just not be 100% top down Stalinism? How much non-governmental jobs could be created that way?

So, if we are to have economic growth, and banking sector stability, much more important than how well capitalized is that they are perceived-risk neutral capitalized. 

Sir, you know how much I have been criticizing current bank regulations, but my first Op-Ed ever, in 1997, was titled “Puritanism in Banking”, and I still think that what we least need is too much of that. God make us daring!

And, since I will try to copy this letter to Professor Miles, I will hereby take this opportunity to ask him whether he has any idea of why regulators want banks to hold the most capital for when something perceived risky turns out risky? Is it not when something perceived ex ante as very safe turns ex post out to be very risky, that one would like banks to have the most of it?

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html 

@PerKurowski

Warning: The “much more bank equity” puritans, while correct, if told to implement it, might be extremely dangerous

Sir, I refer to John Plender’s “Prospect of fund outflows puts banks in tricky territory” October 15.

In it he writes: “Bloomberg has estimated that the cost of equity of 300 large banks was 13 per cent at the end of March, 5 percentage points higher than its 2000-05 average. The authors [of The International Monetary Fund’s Global Financial Stability Report] reckon that the return on equity at banks accounting for 80 per cent of total assets of the largest institutions is lower than the cost of capital demanded by shareholders. This return on equity gap casts doubt on their ability to build up capital buffers to address the next crisis.”

That should be a clear indication of the difficulties that lie before the banks, and a warning sign of having to be very careful with all those puritans out there screaming for much more bank equity, no matter what, and not caring one iota about how to get from here to there.

PS. The first article I ever published, in June 1997, was titled “Puritanism in banking”. In it I wrote: “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”… It seems like time has stood still.

And again, failed regulators, want to show off as puritans!

Sir, the first article I published in my life, in June 1997, was titled “Puritanism in Banking”. In it I expressed serious concerns about how bank regulators, after a crisis, were overdoing it, in order to either show off or to have their previous lax oversight forgiven. It all gave way to a sort of “I am a stricter regulator than you are… no you aren’t… yes I am… no you aren’t… Yes I am, yes I am, yes I am.” 

The article ended with “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.” 

Today, fifteen years later, I get the same sinking feeling when I read about a request for “all banks everywhere to raise their tangible equity capital to 20 percent of assets”, Chris Giles’ “The bank that roared”, July 14. 

Do they not calculate how much bank capital would need to be raised in order to do that? Or are they contemplating keeping the risk-weights, which in such a case would mean causing even higher distortions? 

I believe that the basic 8 percent of capital requirements of Basel is sufficient as long as it is not diluted by risk-weighting. Already to achieve that 8 percent, for all assets, constitutes a major challenge, considering that some current capital requirements for banks are basically zero, like for instance when lending to the “infallible sovereigns”.

Let us beware of upgrading the storm to a hurricane

Sir Gillian Tett reflects well our uncertainties when asking “Is the storm over?” October 4. Now, even if its over, in order to take stock of the damages we will have to wait for quite some time since the costs of any financial crisis are: the actual direct losses existing at the outbreak of the crisis; the losses and costs derived from mismanaging the crisis, for instance injecting too much liquidity and running up inflation; and 3 the long-term losses to the economy resulting from the financial regulatory puritanism that tends to follow in the wake of a crisis and that stops thousands of growth opportunities from being financed. I have hypothesized that each of these individual costs represents approximately a third of the total cost but actually, having experienced a bank crisis at very close range, I am convinced that the first of the three above costs is the smallest.

I mention the above since as we have not yet heard a word from Basle about some flexibility on the minimum capital requirements they imposed on the banks, by perhaps temporarily bringing down the base line from 8% to 7.5%, we should fret about the consequences of the surge in demand for bank capital from having to put assets back on their books and that if not accommodated could upgrade this storm to hurricane.