The latest global capital rules to make banks safer are sensible. Much else that regulators are doing is not
GIVEN how many things went wrong at banks during the financial crisis, it is not surprising that regulators have come up with several new rules to set them to rights. On November 10th the Financial Stability Board (FSB), an international body charged with avoiding future crises, unveiled yet another test banks will have to pass—the fifth so far. At the same time Mark Carney, the head of the FSB and governor of the Bank of England, declared that these measures, if taken together and implemented properly, would “substantially complete the job” of “fixing the faultlines” that led to the crash.
Broadly speaking, he is right. The alphabet soup of rules devised in recent years makes it much harder for banks to be run in the risky manner that was all too common before 2007. New liquidity requirements prevent them from borrowing money on fickle overnight markets while lending it on for 30 years, the practice that felled Northern Rock, the first British bank to fail during the crisis. New rules on capital, including the one unveiled by Mr Carney this week, will force banks to have a decent safety buffer so that tiny changes in the value of their assets do not cast them automatically into the arms of the state.
Better yet, the latest measure ensures that if a bank's shareholders are wiped out there will in future be an additional tier of investors standing between failure and a taxpayer-funded bail-out. “Total loss-absorbing capacity”, in the regulatory argot, will soon include not just the money invested by shareholders, but also that lent by bondholders, most of whom avoided any losses during the crisis thanks to government bail-outs. It is the centrepiece of the FSB's efforts to make sure that no bank is “too big to fail” (see article).
This extra capital is all-important. Before 2007, some banks had such a thin loss-absorbing cushion that a 2% fall in the value of their assets put them out of business. Imposing losses on their creditors involved long and uncertain lawsuits, and so was seldom attempted during moments of crisis. Instead, to stop the panic spreading, governments resorted to bail-outs. Under the new dispensation, however, “systemically important” banks should be able to endure a 20% fall in the value of their assets before placing panicky calls to the central bank.
The need to hold more capital makes banks less profitable—but that is no bad thing: the mammoth profits they made in the boom years were predicated on the subsidy they were receiving in the form of implicit government backing. It may also make them shrink, since one way to raise capital relative to assets is to hold fewer assets. That, too, is for the best, as long as people and businesses can find other ways to borrow. Relying more on stock- and bond-issuance would enable the economy to be financed at much less risk to the taxpayer.
If they want to stay in business, banks will also have to ask shareholders and the bond markets for more money. Attracting the capital that will make banking safer will be hard, with profit forecasts so anaemic. However it will also be made unnecessarily difficult by capricious behaviour from the very watchdogs who are ordering banks to raise the funds.
One problem is the endless tinkering with the rules. For all Mr Carney's talk of finishing the job, global regulators have yet to set the minimum level for several of their new capital requirements. National regulators are just as bad. No bank can be certain how much capital it will need in a few years' time. Pension funds and insurance companies rightly fret that even a tiny tweak in any of the new regulatory tests is enough to send a bank's share price plummeting (or, less often, rocketing).
The dark side of banker-bashing
The other problem is the multi-billion-dollar fines levied by regulators in America and Europe, seemingly calibrated not to the scale of the alleged wrongdoing but to banks' ability to pay. This week six big international banks agreed to hand over billions for manipulating foreign-exchange markets, with little explanation of how the penalties were calculated. New edicts unrelated to capital, such as America's assaults on money-laundering and tax-dodging, add yet more obligations.
Banks can hardly be surprised that regulators have rewritten the rule-book and then thrown it at them. But, for the health of the system, the rules need to be predictable, transparent and consistent. Incredibly, the regulations emanating from America's Dodd-Frank financial reforms are still being written, more than four years after the law was passed. Europe is scarcely better. Impose demanding capital rules, but stop adding more red tape: that should be the mantra of bank regulators just about everywhere.