The fundamental issue that has not yet been faced in the post-crisis reform of banking regulation is that effective reform must lead to less lending.
And at a time when there is a global demand deficit and high unemployment, caused, in part, by a continuing credit squeeze, there is not a lot of official stomach to make the credit squeeze permanent through regulation.
Bankers are saying, in effect: if you don’t want us to lend as much by forcing us to hold more capital, that’s fine – we’ll move into wealth management instead. That’s what NAB has been trying to do in Australia.
So there is a sort of silent struggle going on between regulators and bankers, with politicians in the middle wringing their hands trying to get credit markets moving again so businesses can invest and employ voters.
Over the weekend a team of IMF staffers released a working paper that amounted to a cry of frustration from the regulators. It concluded that the regulatory response to financial crisis is still well short of what’s needed – specifically that Basel III only covers banks, not other financial institutions, that it’s not globally coordinated, and there is still no levy on banks to help pay for failures.
But then last night Switzerland upped the ante on Basel III by imposing extra capital standards far in excess of the new requirements.
Basel III requires a minimum “common equity” (share capital) of 4.5% of risk-weighted assets, but on top of that there is a “conservation buffer” of 2.5% if they want to pay dividends and bonuses (which they all will).
On top of that there is to be a “counter-cyclical buffer”, unspecified during boom times but expected to be in the range 2-3%.
Last night Switzerland announced what is called the ‘Swiss finish’ – Swiss banks will be required to hold 10 per cent common equity – 3% more than the rest of the world’s banks. Moreover, UBS and Credit Suisse will be required to hold another 9% in the form of “contingent capital” – bonds that convert into equity when the bank’s core capital falls below a certain level.
The ‘Swiss finish’ common equity requirement of 10% is also being discussed by UK regulators as a possible requirement for the country’s most “systemically significant” banks.
There is clearly now the prospect of a “race to the top” in banking, where regulators, and the banks themselves for that matter, try to outdo each other in the amount of capital on their balance sheets, and thus the degree to which lending is constrained.
Banking is like a water-filled balloon: if you squeeze one end, the other end bulges. That was seen in the disastrous explosion of shadow banking and financial engineering during the credit boom, which led to the crisis – even though banking itself wasn’t being unduly regulated.
As the IMF staff team points out in their working paper, the only effective global regulatory response to the crisis so far has been a requirement that banks – which represent a “subset of financial services” – hold more capital.
The IMF paper states: “Reforms must address emerging exposures and risks in the entire financial system, not just the banks. Absent a broader perspective, there is a danger that riskier activities and products will migrate to the less (or un-) regulated segments of the system, as occurred with off balance-sheet investment vehicles during the recent crisis.”
That is especially true if there’s a sort of “mine is bigger than yours” capital measuring contest among the bankers and their regulators.
This article first appeared on Business Spectator.
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