February 01, 2013

Higher capital levels for banks need not to make it harder for bankers

Sir, Meredith Whitney writes “Higher capital levels are here to stay. Sure, they make operating a bank a lot less easy than it has been over the past 20 years.”, “US bank bosses must live up to their pay cheques” February 1. 

First, I am not sure that operating a bank has been in anyway easy over the past years, with bankers having to produce the returns on equity that keeps you from being eaten up by the ones on route to too-big-to fail status. And second, I do not think that higher capital requirements will make it harder for the banks, except of course that they will now have to find themselves new shareholders willing to accept lower returns as the price for lower risks. 

Whitney also writes that Banks will have to distinguish themselves through back-to-basics operating results. This will mean a welcome return for the sort of basic analysis by investor they apply to other companies”. She is way too optimistic. While there are regulations that require banks to hold different capital for different assets based on the ex ante perceived risk, it will always be very hard and confusing to analyze banks trying to figure out what will happen, ex-post. 

Can you imagine how it could confuse the life insurance industry if insurance companies were forced to hold more capital when lending to the unhealthy than when lending to the healthy, even after they have cleared for those risk differences by means of the premiums charged and amounts insured?