Capital punishment
Will the new capital ratios under Basel III constrain lending even further, and how much capital is enough capital if central banks and governments are to avoid another bail out of systemically-important banks?How much capital is enough capital for "too big to fail" banks to hold if governments and central banks are to avoid another round of bail outs in the next liquidity crisis? It may sound like an obvious question, but when you consider that Bear Stearns and other banks that came under strain during the 2008 financial crisis were holding what was then thought to be enough capital in terms of Tier 1 ratios, then how much is really enough?
Regulators and central banks are due to meet at the Bank for International Settlements in Basel this weekend to finalise the much anticipated Basel III proposals which are expected to contain new capital and liquidity measures for banks. Markets reacted negatively on Friday after newspapers reported that Deutsche Bank, which did not seek any bail out money during the crisis, was expected to raise an additional EUR 9 billion in capital, ahead of Sunday's meeting. Pending the outcome of Sunday's meeting, are other banks likely to follow suit?
Citing sources with knowledge of Sunday's talks, the UK's Telegraph reported that big banks like HSBC, RBS and Barclays were likely to have to hold more capital than smaller banks, no doubt because the systemic impact of them failing is considered to big for any government or central bank to bear. Reports suggest that banks could be required to have a tier one capital ratio of up to 8% (5% basic and a 2-3% buffer), under the new rules drawn up by the Basel Committee on Banking Supervision. Some banks already have Tier 1 capital ratios in excess of this, particularly Asian banks that have lower loan/deposit ratios and are more reliant on deposits than the wholesale markets for funding.
Even if there is no change in the minimum percentage that banks need to hold in capital as a result of Sunday's meeting, Richard Barfield, director, PricewaterhouseCoopers LLP said it is important to remember that 1% core tier 1 capital under Basel III ‘new money’ is more expensive than 1% ‘old money’ under Basel II. "This is because of the tighter definition of what is allowable as capital and an increase in regulatory requirements for some assets," he explained.
Regulators need to strike a fine balance, said Barfield. Setting capital limits too high of course will constrain lending, which is already under pressure, and setting it too low will not encourage stability. But is there too much emphasis on capital ratios as a panacea for avoiding future bank bail outs? It's a bit like everyone prescribing central clearing for OTC derivatives. “Stipulating capital requirements is just one part of improving financial stability– strengthened risk-management and improved hands-on oversight by experienced supervisors, which are less costly and arguably more effective, will also be critical to successful reform," remarked Patrick Fell, director, PricewaterhouseCoopers LLP.
Date Posted:10th September 2010