Commentaries

from Rolfe Winkler:

Bank capital buffers increase, still not high enough

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The superstructure of financial reform may be stalled in Congress, but at least regulators are forcing banks to raise capital. Since the nadir of the financial crisis in the fourth quarter of 2008, the Big Four have more than doubled their common equity, raising another $55 billion just in the fourth quarter.

The question is whether they've raised enough. With capital only a bit above early '08 levels, especially among regional banks, the answer is most likely no.

Stepping back for a minute, it's helpful to remember why capital is so crucial. The most important reason is that it provides a buffer to absorb losses from the asset side of the balance sheet. As assets are written down, a too-thin equity capital cushion leads to a run among creditors who race to get out before taking a loss.  Bank runs -- whether the run-of-the-mill type among depositors or the high finance equivalent among short-term creditors -- can quickly bring a financial system to its knees.

Luckily, regulators appear to be laser-focused on capital. Documents published in December by the Basel Committee -- an international collection of bank regulators -- would redefine capital in a number of productive ways.

More stringent capital requirements are also a back door way to accomplish other regulatory goals. For instance, the "size" component of the recently proposed "Volcker Rules" is designed to limit reliance on non-deposit liabilities. The more capital banks are required to hold, the smaller these liabilities.

from Rolfe Winkler:

Banks still need bigger cushions (Q2 TCE update)

It was a surreal moment two weeks ago when analysts on Goldman Sachs’ earnings conference call pressed CFO David Viniar to jack up leverage. They seem to think that the worst of the credit crisis is behind us, so Goldman should goose its risk profile to increase returns. This is remarkably short-sighted.

Yes, leverage is down, but only relative to the obscene levels reached a year ago.  Measured by tangible common equity, the biggest banks are still levered over 20 to 1. If banks learn nothing else from the financial crisis, it’s that they should err on the side of prudence, carrying substantially more capital than appears necessary.

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Tangible common equity remains the crucial measure of bank capital because it’s the primary cushion to absorb losses. When that cushion gets low, creditors panic. Bank runs ensue and the financial system ceases to function.

A nickel of equity for every dollar of assets is a pathetically small capital cushion.  And today, banks substitute federal guarantees for liquid capital.  Policymakers are afraid to remove the guarantees because they don’t want to precipitate another collapse. The financial system can’t stand on its own until its capital cushion is rebuilt.