The UK chancellor's speech contained sensible plans for change but nowhere did the word 'capital' appear, writes Hildebrand for the FT's A-List.
The speech, as with much of the current regulatory and reform agenda, focused largely on structures. On the one hand the future structure of banks themselves, and on the other, the structure of the regulatory apparatus that will provide banking oversight. In that context, what received most attention was the chancellor’s proposal to “electrify” the ringfence between retail and investment banks.
There is nothing wrong with an effective ring fence. But as energy and attention is channelled towards such structural issues, it risks being channelled away from the issues of excessive leverage and insufficient capital – the fundamental causes of the crisis. Adequate capital is crucial for building confidence in the banking industry. It is capital that enables banks to absorb the losses that are inevitable as financial cycles run their course. Despite the progress made on capital in the context of the Basel III reforms, the apparent move away from focusing on capital constitutes, I believe, a cause for serious concern.
Unfortunately, structural reforms, no matter how thoughtfully designed and carefully implemented, will offer only limited defence for society if banks are allowed to become overly leveraged again. No matter the charge of the electrical current running through a ringfence, banks may still find ways under, around or over it. And even if the ringfence holds, the failure of a large bank, whether purely retail or purely casino, risks having destabilising, systemic effects. The core and unavoidable truth is that if banks are not sufficiently well-capitalised, they will always be vulnerable. And if they are large or interconnected enough, they will be potentially dangerous.
This means that politicians and regulators need, collectively, to have the courage to continue to focus on, and be tough on, the issue of capital. Inevitably, that will be in the face of intense lobbying from those bankers who hope to return to the days of high leverage, high return on equity and high compensation. But politicians and regulators need to maintain a focus on capital, and set simple, clear and transparent rules that force banks to hold enough. Market forces will then take care of much of the rest.
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