Wednesday 24 July 2013
Vince Cable and "the capital Taliban"
The previous article was about equity ("capital") ratios in banks. Today, the Business Secretary Vince Cable has described those in the Bank of England pushing for more equity in banks as "the capital Taliban". The FT's (freely accessible) Alphaville blog has an excellent list of problems with his remarks.
Monday 8 July 2013
Bank regulation
Good headlines, insufficient policy
The government has today responded to the Parliamentary Commission on Banking Standards, which was set up to make recommendations on bank regulation in light of the LIBOR scandal. George Osborne is to implement most of the recommendations of the commission, notably the headline grabbing move to allow reckless bankers to be jailed. This policy no doubt appeals to the public, and rightly so. But it is far, far less important than requiring adequate equity (or 'capital') standards in banks - or in other words requiring a higher 'leverage ratio'.
The leverage ratio is the percentage of a bank which is funded by equity rather than debt. It is so important because it determines how close to the edge a bank is operating. A leverage ratio of, say, 10 percent means that a bank would be insolvent and in need of a bailout if it experienced a decline of 10 percent in the value of its assets.
On this crucial issue, the government has rejected the view of the Commission, which was also the view of the earlier Vickers Report, that the leverage ratio of 3 percent required by the most recent set of global regulatory rules ('Basel III') is too low. Vickers had recommended a ratio of 4 percent.
Both of these numbers are far too low, and the government is wrong to endorse the smaller of them. It is madness to have banks which cannot withstand a decline in asset values of only three percent. The principal argument offered by bank lobbyists and commentators against higher leverage ratios is that they reduce lending to the economy. But a leverage ratio is a condition on how a bank is funded, not what it does with that money. There is no good reason why higher bank equity should reduce lending. In a recent book, finance academics Anat Admati and Martin Hellwig elegantly demonstrate that higher equity requirements make banks much safer, reduce perverse incentives, and come at no cost to society. They refer to the arguments against them - such as falsely alleging that they will reduce lending - as articles of "the bankers' new clothes".
It is of crucial importance to society that banking is made safer, to avoid a repeat of the financial crisis. This can be achieved at virtually zero cost to society. While headline grabbing measures like those announced today might cause some marginal improvements, the really important debate is being skirted. Much bolder reform is needed.
The government has today responded to the Parliamentary Commission on Banking Standards, which was set up to make recommendations on bank regulation in light of the LIBOR scandal. George Osborne is to implement most of the recommendations of the commission, notably the headline grabbing move to allow reckless bankers to be jailed. This policy no doubt appeals to the public, and rightly so. But it is far, far less important than requiring adequate equity (or 'capital') standards in banks - or in other words requiring a higher 'leverage ratio'.
The leverage ratio is the percentage of a bank which is funded by equity rather than debt. It is so important because it determines how close to the edge a bank is operating. A leverage ratio of, say, 10 percent means that a bank would be insolvent and in need of a bailout if it experienced a decline of 10 percent in the value of its assets.
On this crucial issue, the government has rejected the view of the Commission, which was also the view of the earlier Vickers Report, that the leverage ratio of 3 percent required by the most recent set of global regulatory rules ('Basel III') is too low. Vickers had recommended a ratio of 4 percent.
Both of these numbers are far too low, and the government is wrong to endorse the smaller of them. It is madness to have banks which cannot withstand a decline in asset values of only three percent. The principal argument offered by bank lobbyists and commentators against higher leverage ratios is that they reduce lending to the economy. But a leverage ratio is a condition on how a bank is funded, not what it does with that money. There is no good reason why higher bank equity should reduce lending. In a recent book, finance academics Anat Admati and Martin Hellwig elegantly demonstrate that higher equity requirements make banks much safer, reduce perverse incentives, and come at no cost to society. They refer to the arguments against them - such as falsely alleging that they will reduce lending - as articles of "the bankers' new clothes".
It is of crucial importance to society that banking is made safer, to avoid a repeat of the financial crisis. This can be achieved at virtually zero cost to society. While headline grabbing measures like those announced today might cause some marginal improvements, the really important debate is being skirted. Much bolder reform is needed.
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