Generals lose their current wars by fighting the last one. And regulators in the City of London and on the continent are creating a new crisis because they’re making exactly that mistake.
The European Commission recently unveiled a package that it said would “strengthen Europe’s banking sector and support growth.” The measures promised to revise standards that limit how banks lend, as well as to make it easier to meet capital requirements. But they may not go far enough.
These standards were the “endgame” of the Basel III process that started after the 2008 banking meltdown. The rules are supposed to prevent another crisis. They apply globally, though it’s up to each jurisdiction to figure out how to implement them.
The world has changed since 2008, and the continent’s financial sector — and some member states — have been pushing the Commission to recognize this fact when applying Basel III. Brussels is, in fairness, already moving faster than its usual tortoise pace. That’s in part because of fears that President Donald Trump’s US deregulation drive will further disadvantage Europe’s lenders.
Regulators are going through a similar bout of soul searching about capital norms in the UK, where banks are complaining to the Bank of England that its current regime punishes them for investing in their own future, unlike America’s much kinder treatment of Wall Street. Whereas US lenders are allowed to include their massive internal spending on digitalization in the capital stock that regulators assess, Britain’s banks cannot do the same.
This is just one consequence of a post-crisis regulatory mindset in Europe that’s built around managing losses if a bank has to be liquidated, while ignoring the need to invest, modernize and compete. Once the UK’s harsher approach is factored in, according to the Financial Times newspaper, British lenders will have regulatory capital requirements almost two percentage points higher than their transatlantic rivals.
The City’s complaint fits into a long-running campaign to get UK authorities to update how they set capital requirements — an effort parallel to what is going on in Brussels, and driven by similar worries about Wall Street’s dominance. Late last year, the BOE’s Financial Policy Committee cut its system-wide benchmark for “Tier 1” high-quality capital to 13% of an institution’s risk-weighted assets. That was down by a percentage point from the earlier requirement. But this would still leave the UK with the highest capital norms in the G7. Clearly more is needed.
A few weeks ago, the FPC insisted that the 13% ratio was right, but it did admit — finally — that the system forces banks to retain too much capital, limiting their ability to lend. The BOE promised it would bring the overall leverage ratio for large banks “within the range of other jurisdictions globally.”
It will take more than that to repair two decades of damage. The basic problem was already clear before Trump’s deregulation crusade: Growth has stalled across Europe over that period partly because private investment never recovered. And unless the continent unlocks long-term finance swiftly, it will be shut out of the next few decades’ worth of economic progress as well. Just because no bank has failed doesn’t mean that this isn’t a crisis of finance.
How much banks lend, to whom, and for how long shouldn’t be defined purely in terms of the health and competitiveness of the finance sector itself. Growth and supporting the sovereignty of important industries via investment are a larger question than that. Sadly, it’s one that regulators are not incentivized to address, as is becoming abundantly clear. Allow more risk-taking, and more investment will follow. Banks conserving their capital will not originate the deal flow that feeds the private markets Europe so desperately needs.
But monetary technocrats will not allow more risk into the system unless politicians explicitly tell them to. That’s exactly what leaders across Europe must do, especially if they want to see off the populist threat by bolstering economic output.
Policymakers accept that restoring growth, renewing investment and rearming the continent needs private capital to step up. They must now concede that rules from a time when the continent was drowning in reckless credit no longer fit the moment. Today, there’s too little long-duration capital chasing too few productive assets, and investment banks have scant incentive to change things themselves as they make comfortable profits from betting on markets without breaking a sweat. Concessions from Brussels and a grudging review in London are small admissions that the continent’s finance industry must be put to more constructive use. But they don’t yet constitute the necessary urgent rethink.
Nobody wants the old Wild West of casino banking back again. But countries with the harshest capital-adequacy norms in the world will never be able to compete; they’ll just continue their post-crisis decline. We worry on this side of the Atlantic that we haven’t gotten over 2008. The truth is we’ve never even tried to return to normal.
Disclaimer: This report is auto generated from the Bloomberg news service. ThePrint holds no responsibility for its content.