Fed’s capital proposal not as tough as feared, may give U.S. banks advantage

By Guest Contributor
December 22, 2011

By Rachel Wolcott

NEW YORK/LONDON, Dec. 22 (Thomson Reuters Accelus) - Considering the cost of the financial crisis to the American taxpayer — anywhere between $700 billion and $12.8 trillion depending on who you talk to — the proposed capital rules the Federal Reserve published yesterday seem pretty lenient, compare to those mooted by some European countries.

However, it is a certainty that the same U.S. bank CEOs who have been so vociferous in their criticism of any increase in capital requirements, will continue their efforts to pare down the amount of capital they are required to hold.

The Fed’s proposals follow the Basel III capital standards bringing the Tier 1 common risk-based capital ratio requirement to 7 percent, plus a surcharge of up to 2.5 percent for the most complex firms. It is unclear how much the surcharge will be for banks that are above $50 billion in assets, but are not in the group of eight institutions considered globally systemic. The Fed has not made a decision on that issue, but any additional surcharge is likely to be small.

However much U.S. banks complain about capital rules and Basel III, it looks like their Swiss and UK counterparts are in for tougher treatment. Wary of the systemic risk big banks like Credit Suisse and UBS AG pose to its financial system, Swiss regulators have proposed that these banks hold a 19 percent cushion against lending. Ten percent of that would be held in common equity and nine percent in contingent capital. Basel III only requires a seven percent cushion. In addition big banks may also be required to separate their investment banking activities from other lending and retail businesses.

In the UK, the government has signaled its intention to adopt most of the proposals from the Sir John Vickers’ Independent Commission on Banking. Vickers proposed ring-fencing investment banking activities and a 17-20 percent capital buffer, however a recent statement from the UK’s chancellor of the exchequer seemed to indicate it won’t be as high as feared.

Depending on the Fed’s final ruling, U.S. banks could maintain a competitive advantage over some European counterparts. While U.S. banks will have to hive off some of their derivatives trading operations to comply with the Dodd Frank Wall Street Reform and Consumer Protection Act 2010, they will not be asked to ring-fence their investment banking business completely, as is set to occur in the UK. That kind of move would put even more constraints on banks’ capital.

CAPITAL IS NOT A PANACEA

The Fed and the global regulatory community are committed to avoiding a repeat of the ongoing banking crisis that erupted in 2008 with the collapse of Lehman Brothers. New capital requirements and legislation and regulation, which in the U.S. came in the form of the Dodd Frank Wall Street Reform and Consumer Protection Act 2010, are part of their answer to protecting the U.S. financial system and ensuring U.S. banks are not too-big-to-fail.

The requirement to hold more capital might stop big banks from taking too much risk, but some financial markets experts observe that the regulators’ focus on capital adequacy requirements may be missing some of the lessons of the financial crisis. Nor will increased capital necessarily prevent another crisis.

Ernest Patrikis, a bank advisory partner at White & Case said: “The issue is capital is not a cure all. During the credit crisis all the major banks were well capitalized. The issue really was what really was the valuation of their assets? And that’s what the market was doing, was saying it didn’t believe the valuation of assets. So the market was making its own discount.”

What is needed, argues Patrikis is more supervision from the regulators. Regulators need to take the rules that they have and act as true watchdogs over the financial services industry. He pointed to the recent MF Global bankruptcy as an example of how the regulators need to be examining firms’ books, their accounting methods, assessing risks, talking to risk managers and asking a lot more questions.

Increased capital requirements should, however, provide an important cushion when the banking system is hit with a shock. Some experts believe that as the financial system has become more globalized and interconnected, it has become more unstable. Unless there is some kind of fundamental change, these crises will continue to occur. Banks are going to have to get used to holding more capital. However, capital alone will not protect the global economy from systemic risks.

Matthew Richardson, Charles E. Simon professor of financial economics at New York University’s Stern School of Business told Thomson Reuters: “My main problem with Basel III Accords is that they’re a lot like Basel II, which are a lot like Basel I. And that approach does not seem to work. It chooses winners and losers by the way they impose capital requirements. It’s very institution-based so it allows systemic risk to build up in the system.”

PHASED IN

No matter what the final outcome is U.S. banks will have plenty of time to prepare for the new capital requirements. Banks will not have to implement Basel III fully until 2019 and probably will not have to start increasing their capital buffers until 2013.

While some argue that dire economic times like the present are not the time to task banks with capital increases that could staunch the flow of credit, there is an argument for bringing them in sooner.

Patrikis said: “The Basel III rules have a delayed effect to 2013, and that to me is a joke. I understand the need for transition and on the other hand if X is the right amount of capital in three years, it’s right today.”

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus.  Compliance Complete (http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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Basel I, II and III all presuppose that ex-ante risk perceptions are correct and therefore, by means of low risk-weights, allow for very little bank capital when lending to what is perceive as “not-risky”… like triple-A rated securities and infallible sovereigns!

That is loony because there has never ever been a bank crisis resulting from excessive exposure to what ex-ante is perceived as risky… they all have resulted from excessive exposures to what ex-ante was perceived as absolutely not risky.

When will the regulators understand that their duty is to regulate for the possibility that the ex-ante perceptions about risk-turn out to be wrong?

If the moderator allows it here is a video that explains how the regulators rewarded the banks for not taking risks and thereby caused the safe-havens to be dangerously overcrowded http://bit.ly/dFRiMs

Posted by PerKurowski | Report as abusive