BANK´S CAPITAL / THE FINANCIAL TIMES LEX ( RECOMMENDED READING )

Banks’ capital

Published: November 23 2009 15:05

Repeat after me: banks need more capital and better quality capital. The post-crisis regulatory mantra has been accepted almost universally. But the tricky process of determining what that means is just beginning. It is likely to mean further capital raising by banks globally – not just because, as the head of the International Monetary Fund said on Monday there are substantial bank losses still to be revealed. Capital itself remains a moving target.

There are two basic questions to consider on regulatory capital: what should go into it and what goes on top of it? The first has thus far garnered more attention. Loss- absorbing capital, consisting of common equity and reserves, is in favour while more complicated hybrid structures will be subject to limits. However, varying approaches to the second question – the type of risk-weighted assets that capital is used to support – can make comparisons between banks almost meaningless.

Standard & Poor’s argues that this owes as much to subjective modelling assumptions and inconsistent regulatory strictures as to underlying risk. Consider the UK’s basket-case banks, for example: HBOS models about three times the level of unexpected losses on corporate exposures as Royal Bank of Scotland. Meanwhile, Commonwealth Bank of Australia, presumably rather peeved, has pointed out that were it regulated by the UK’s Financial Services Authority, its tier one ratio would be almost 300 basis points higher.

Capital ratios are a valuable but imperfect tool for assessing banks’ strength. Redefining existing standards will take years, with implementation some three years away and options to grandfather past practices extending far beyond that. Meanwhile, banks are creating new types of capital, such as contingent convertibles, which reference a capital ratio that could change dramatically. Nothing is ever as simple as the sound bite.

Copyright The Financial Times Limited 2009.