A Return to Risk
There is a false sense among some regulators that more capital is the 'solution' to banking problems. Takafumi Sato, commissioner of Japan’s Financial Services Agency, takes issue with this supposed axiom. Writing last week in the Financial Times, Sato argues that bank management needs to change its (excessive) risk-taking behavior, with capital acting as the ultimate backstop:
Just asking for more capital will not cure the disease of capitalism. To avoid a recurrence of crises, we need a paradigm change. A global community adopting a uniform platform is vulnerable to a virus, as we have witnessed during the current financial pandemic. Capital adequacy regulations should be designed to foster diversity in business models, demanding the right level of capital for the business type of the bank in question.
More capital and no change in behavior leads to nothing - hence the importance of governance, where the reforms announced to-date, focusing primarily on executive compensation, are (at least in my mind) very timid in nature.
Meanwhile, banks appear to be returning to their pre-crisis strategies of high-risk, high-return investing. The FT reports today that investment banks are coming up with ‘innovative’ solutions to reducing their cost of risky capital:
The schemes, which Goldman insiders refer to as “insurance” and BarCap calls “smart securitisation”, use different mechanisms to achieve the same goal: cutting capital costs by up to half in some cases, at the same time as regulators are threatening to force banks to increase their capital requirements.
Together with an earlier report about Barclays aggressively hiring i-bankers (having sold BGI, its most stable but 'boring' subsidiary) and offering them big bonuses, it is becoming more and more apparent that the post-crisis financial world is (depressingly) turning out to be similar to the pre-crisis one.
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The commissioner of Japan’s Financial Services Agency Takafumi Sato warns in the title of this article in FT that “Tightening capital rules could increase risk-taking”.
Given that the current minimum capital requirements arbitrarily concocted in Basel authorize a marginal leverage of bank equity of 62.5 to 1 if the borrower has an AAA to an AA- rating, it is hard to even comprehend what increased risk taking he refers to.
Excessive risk taking was never the problem. It was the excessive risk-aversion of the regulators that created an amazing regulatory bias in favor of what was perceived as being of little risk which brought this crisis upon us. In this respect we might in fact need some increased risk-taking in the more risky projects and less risk-taking in the low risk projects.
This crisis did not originate from risky Argentinean railway projects but from investing in the safest assets, houses, in the safest country, the US, in securities rated AAA. Who can call that excessive risk taking?
Posted by: Per Kurowski | Jul 7, 2009 1:33:20 PM
Capitalism is based on a foundation of democracy: Free will. With human beings' minds being so dynamic and unpredicatable the job of a regulator is now harder than ever. You can't just legislate for every economic activity.
Posted by: Andrew Njeru | Jul 8, 2009 10:48:14 AM
If the regulators of the insurance companies would decide to follow the regulatory paradigm concocted by the Basel Committee, then they would pick three health inspection agencies to rate the health of the insured and require the insurance companies putting up more capital when they sell health insurance to someone with a low health rating and letting it almost off the hook if the insured is deemed to be in tip top form.
All in all the financial regulations coming out of Basel add up to a crime against common-sense.
Posted by: Per Kurowski | Jul 9, 2009 11:31:14 AM