November 19, 2016

Like bank-managed risk based capital models, should children also set the nutrition values that determine their diet?

Sir, James Shotter writes about differences of opinion between American and European bank regulators, with respect to allowing big banks to use their own risk models to help determine how much capital they should hold. “Bank rules benefit only US, says Deutsche chief” November 19.

Sir, knowing that banks have huge incentives to reduce the capital they need to hold, in order to by means of higher leverages obtain the highest returns on equity possible, that is perhaps the greatest, but far from the only display of naiveté by the Basel Committee and the Financial Stability Board.

It is like allowing children to set the nutritional values that will determine their diet like for chocolate cake, ice cream, broccoli and spinach.

In this discussion the relevant question is: “European regulators, do you believe European banks to be genetically or by some other reason more disposed than US bankers to resist the temptation of high returns on equity and bonuses?”

If the answer is “Yes”, so be it, and then the market will evaluate that answer. My bet is that the market will long-term prefer better capitalized banks… as well as trusting more regulating nannies that trust less the children in their care.

“Valdis Dombrovskis, the EU’s financial regulation chief, said… he would not accept changes that significantly increased how much capital European banks had to hold.”

Is that so? Does he really want US banks to become stronger than the European under his watch?

Clearly there is a conflict between wanting the banks to hold more capital with wanting the banks to also serve the credit needs of weak economies. But there are ways to harmonize, like grandfathering any changes in the capital rules meaning leaving them as is for all the current assets of banks, and, for instance, applying a fixed 8 percent capital requirement for all new assets.