Opinion

Felix Salmon

Basel: the Sifi surcharge arrives

By Felix Salmon
June 27, 2011

Basel has spoken, and the Sifi surcharge — the amount of extra capital that will have to be held by systemically important financial institutions — will range from 1% to 3.5%, with no bank in the first instance being subject to a surcharge of more than 2.5%.

This is more or less in line with expectations, and in fact is maybe a little bit tougher than was expected by some of the pessimists. It’s not the size of the surcharge which is particularly impressive, but more its nature: it’s made up only of the highest-quality capital — no CoCos allowed. And the fact that it’s based on a sliding scale means that it has the important feature of both dissuading the biggest banks from getting bigger and indeed giving them an incentive, at the margin, to get smaller.

The surcharge doesn’t end too big to fail, of course. Bethany McLean is absolutely right that capital requirements aren’t some kind of panacea, and that in and of themselves they don’t prevent crises. But they’re still a crucial part — along with liquidity and leverage constraints, and a crackdown on off-balance-sheet vehicles — of making the global banking system more robust, less pro-cyclical, and less prone to catastrophic failure.

And while the Sifi surcharge won’t stop banks growing to the point at which they have to be bailed out in extremis, it might make such growth significantly less profitable than it was in the past.

One of the peculiarities of the global financial crisis was the behavior of Citigroup’s deposits — here was a huge and insolvent bank, most of whose depositors were not insured. (Citi has many more deposits outside the US than it has domestically.) I was very worried about this: if those depositors moved their money out of an insolvent bank and into something safer, the consequences for Citi could have been disastrous. But the bank run never happened, and in fact over the course of the crisis Citi’s deposit base went up. That’s known as the moral-hazard play: depositors the world over trusted the US government to bail out Citi, as in fact it did, and knew that as a result their money was safe, backstopped by an implicit US government guarantee. Which you certainly can’t say about money held in a foreign branch of a mid-sized community bank.

That’s just one of many advantages to being huge, and as a result it’s great that Basel is forcing the likes of Citi to hold more capital than their smaller counterparts. It might be a relatively small victory, but every win counts.

Comments
6 comments so far | RSS Comments RSS

All this does is lessen the impact of a bankruptcy for its creditors, ever so slightly, and gives the world a slightly earlier signal of a potential bankruptcy, allowing for an earlier intervention.

Maybe that’s all they really wanted?

Posted by GRRR | Report as abusive
 

Huh??

Have you forgotten so soon?

For immediate release November 23, 2008 Joint Statement by Treasury, Federal Reserve, and the FDIC on Citigroup

Washington, DC — The U.S. government is committed to supporting financial market stability, which is a prerequisite to restoring vigorous economic growth. In support of this commitment, the U.S. government on Sunday entered into an agreement with Citigroup to provide a package of guarantees, liquidity access, and capital.

http://www.federalreserve.gov/newsevents  /press/bcreg/20081123a.htm

Posted by ExaminerCarter | Report as abusive
 

Since you mention Citi … Note that, as of March 31, 2011, both Citigroup’s and Citibank’s Tier 1 Common ratios (11.34% and 15.13%, respectively) were comfortably above the required rates under Basel III (including the maximum SIFI surcharge). See pages 27 and 31 of Citi’s 10-Q for 1Q11: http://www.citigroup.com/citi/fin/data/q 1101c.pdf.

Posted by Kamekon | Report as abusive
 

not sure that bankruptcy was ever the concern for this. after all, if a bank only has capital 1/10 their loan value, creditors will get nothing more than that. the reason the FDIC exists and why bank runs aren’t a common every day occurrence is because depositors are protected. if they weren’t every one would be on the look out for signs their bank was going under. which really hurts the economy. its why banks should really be a boring business. with little to no risks. as opposed to what we have today, of the wild west version of banks. just like the days before the great depression. and the great bank collapse

Posted by willid3 | Report as abusive
 

Bethany McLean is being obstreperous when she writes:

“If banks had more capital, wouldn’t they take less risk, because the bankers would have more to lose? I’m not sure the answer is yes….”

Huh? What is she “not sure” of? If banks had more capital, then imo they would *BE* less risky.

Higher capital requirements for banks will not, indeed, increase the “transparency in the valuation of their assets,” but it’s unreasonable to bemoan the former for not being the latter.

Posted by dedalus | Report as abusive
 

My impression is that, de facto, the capital requirement drops during recessions and financial shocks; the Fed doesn’t want to require immediate compliance or shut down banks when they’re hardest hit, and insofar as this is a rainy-day cushion, it makes sense to allow it to drop a bit when it rains. It would be nice to formalize this, though that may be very difficult to do for a number of different reasons. The rules need to be (presumably are?) coupled with an explanation of how a bank that is out of compliant is to be forced to come into compliance, e.g. over what time frame and subject to what penalties. Perhaps the Fed can just lend “equity” to any bank that is short at a 24% interest rate; a bank whose cost of equity is expected to exceed 24% for a sustained period of time should just be shut down, if at all possible, but other banks would find this a strong incentive to liquidate illiquid assets and reduce the loan portfolio subject to a rule that 95 cents on the dollar now is better than 96 cents on the dollar next month, but not than 97 (assuming a cost of equity somewhat below 12%). Well, maybe 36% would be better. But I think something of this qualitative nature would make sense.

Posted by dWj | Report as abusive
 

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