Watering Down Banking Regulations


“IT was always the French and the Germans,” grumbles a senior financial regulator, blaming counterparts from those two countries for undermining international efforts to increase capital ratios for banks. Every time the Basel committee, a grouping of the world’s bank supervisors, neared agreement on a higher standard, he says, a phone call from the Chancellery in Berlin or the Trésor in Paris would send everyone back to the table.

Similar phone calls almost certainly inspired the committee’s decision on January 12th to water down a proposed new “leverage ratio” for banks. It had originally suggested obliging banks to hold equity (the loss-absorbing capital put up by investors) of at least 3% of assets. In theory, that standard will still apply. But the committee came up with various revisions to how the ratio is to be calculated, in effect making it less exacting.

The new rule will allow banks to offset some derivatives against one another and to exclude some assets from the calculation altogether, thus making their exposure seem smaller. Analysts at Barclays characterised it as a “substantial loosening”. Citibank called it “significant regulatory forbearance”. Shares in big European banks such as Barclays and Deutsche Bank surged to their highest level in nearly three years on the news.

Leverage ratios have their critics—even outside overleveraged banks. They contend that leverage is a crude and antiquated measure of risk compared with the practice of weighting assets by the likelihood of making losses on them, and calculating the required cushion of equity accordingly. The chances of losing money on a German government bond, the argument runs, are much smaller than they are on a car loan; but a simple leverage ratio makes no distinction between the two. As a result, leverage ratios might actually encourage banks to buy riskier assets, in the hope of increasing returns to shareholders. Officials at Germany’s central bank, for instance, have argued that a binding leverage ratio “punishes low-risk business models, and it favours high-risk businesses.

”Bankers also claim that tough leverage requirements risk stemming the flow of credit to the economy, as banks shrink their balance-sheets to comply. BNP Paribas, a French bank, says this would particularly disadvantage European banks because they do not tend to sell on as many of their home loans as American ones. The full extent of the new change is difficult to gauge, partly because there is still some uncertainty surrounding the rules. Yet a rough calculation suggests that they have been loosened just enough to allow most big European banks to pass the 3% test. Without the committee’s help as many as three-quarters of Europe’s big banks might have failed the test (see chart).

A detailed analysis by Kian Abouhossein of J.P. Morgan Cazenove, an investment bank, suggests that under the old rules big European banks may have had to raise as much as €70 billion ($95 billion) to get their leverage ratios to 3.5%, which is far enough above the minimum for comfort. Yet the new rules alone may improve big European banks’ leverage ratios by 0.2-0.5 percentage points compared with the previous ones, he reckons—enough for most to avoid raising new capital.

That does not mean banks will be able to shrug off the new leverage ratio entirely. Simon Samuels, an analyst at Barclays, expects it will prompt some European investment banks to reconsider their strategies. Some may have to cut lines of business and reduce their assets. That hints at the potency the measure could have had, if the regulators had allowed it.

Leverage ratios: Leavened, Economist,  Jan 18, 2014, t 72

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