Debt: The politicians heading for Seoul this week might be forgiven for disregarding a call by a group of eminent professors for bank leverage ratios to be increased to 15 per cent, a number five times larger than the minimum agreed by regulators in Basel. But the academics' warning does highlight an uncomfortable fact, that the current system perpetuates the curse of leverage in finance.
Bankers love leverage because it amplifies profits while, as the crisis showed, losses are socialised onto taxpayers. Unsurprisingly, the taxpayers have twigged that banking is not real capitalism. The regulatory “fix” of Basel-III rightly cracks down on some of the worst abuses, but entrenches a bureaucracy of bank examiners and systemic risk committees that are supposed to rein in banks in the future. Untested, new forms of contingent capital or debt write-down mechanisms are intended to make leverage less of a free lunch than it is today. But it would be far simpler to eliminate or reduce the incentives for excessive borrowing by banks in the first place.
Almost all countries' tax systems encourage banks - and other companies - to finance themselves with debt rather than equity by making interest payments tax deductible.
Getting rid of that perk is not the job of bank regulators, but a question for fiscal policymakers. Germany already limits the deductibility of interest payments against tax, but could go further. In the UK, one of the most pro-leverage tax regimes, a recent clamp-down on tax breaks for overseas interest expenses contained an exemption for banks and securitisation vehicles. No tax regime is more debt friendly than America’s, but at least here there is a genuine prospect of reform, with a bipartisan proposal in Congress and a Presidential commission both urging that the fiscal balance be shifted towards equity finance. It would be unrealistic to expect last-minute changes to Basel-III, but a more equity-based banking system resembling real capitalism will never emerge from it without a fiscal push. The leaders at the G20 meeting fretting about the burden of government borrowing would do well to keep that in mind.
