Bank capital: Banks have spent most of the past four years resisting tougher rules. But, it’s time to go easy on them. With markets tumbling and economies stuttering, banks are being more risk-averse than reckless. A little slack from the regulators might encourage them to lend. Shares in banks on both sides of the Atlantic are back at levels last seen in the spring of 2009.
The market capitalisation of most big western lenders is now below the value of their tangible common equity, implying they are unlikely to generate a decent return on equity for the foreseeable future. In effect, investors are telling banks to shrink. But, if lenders heed that advice, economic growth will be even more constrained. Lightening up on banks is within the remit of the new breed of “macro-prudential” committees set up in response to the crisis.
So far, the focus has been on how they can deflate future bubbles before they pop. But, the immediate priority might be for some pumping. One radical suggestion is to scrap or delay the new Basel-III bank capital regime. That would be a mistake.
While far from flawless, the new rules fix many of the distortions that helped trigger the credit crunch. Delaying implementation, meanwhile, would have little effect. Officially, Basel-III does not fully come into force until 2019, yet every large bank is aiming to meet the seven-per cent minimum ratio by 2013. Fortunately, the new Basel rule book has a tool designed to smooth out the peaks, and, crucially, the troughs of the economic cycle.
This is the so-called counter-cyclical capital buffer, which can be set anywhere between 0 and 2.5 per cent of risk-weighted assets. In good times, the buffer should be higher in case a bubble is about to burst.
By the same token, capital cushions should be worn down in times of difficulty. If regulators signaled their intention to set the buffer low — at say, 0.5 per cent — they would send a powerful message that the post-crisis capital rebuild was coming to an end. Fixing the counter-cyclical buffer wouldn’t let banks off the hook. The world’s largest “too big to fail” institutions still face extra capital requirements.
Countries like Switzerland are pushing through even tougher standards. Even so, for regulators who have spent the past four years responding to the last downturn, it’s time to make it clear that they’re equally committed towards avoiding another one.