BANKS PERSIST IN BEING THEIR OWN WORST ENEMY / THE FINANCIAL TIMES ( HIGHLY RECOMMENDED READING )

Banks persist in being their own worst enemy

By Tony Jackson

Published: January 17 2010 19:06

Until lately, received wisdom said that reform of the banking system was running into the sand. Then came the UK tax on bank bonuses and the proposed levy by US president Barack Obama. So where do we stand now?

The standard description of both measures is “populist”, the premise being that whatever the people want is ignorant or wrong. And indeed, such political moves arguably matter less than detailed work behind the scenes by regulators.

But in the end, regulatory proposals have to be agreed by politicians. If recent events are a guide, bank lobbyists may find those politicians stubborn.

So what do the regulators have in mind? The key texts are two consultative papers issued last month by the Basel Committee of global central bankers. Being long and detailed, they got lost in the Christmas break. But by last week there were yells of protest at some of the proposals.

Before getting down to detail, let us reflect that the whole reform process is playing out in a slightly unexpected way. At the outset, there seemed a clear conflict between regulators taking the time to get it right and acting quickly to harness popular resentment.

But in the event, bankers gave the regulators all the time in the world by preserving that resentment through their own behaviour.

The key is bonuses – in some ways a side issue, but not if they end up shaping the whole reform process.

They certainly annoy the Basel Committee. If banks persist in frittering away their capital in bonuses and dividends, it says, they “reduce their resilience if the recovery falters”.

Indeed, it is “not acceptable” for them to use bullish forecasts to justify high distributions. That passes the risk of economic relapse from their shareholders and employees – where it belongs – to their depositors (or presumably, in effect, to the taxpayer).

Perhaps, as the chief executive of UK state-owned Royal Bank of Scotland told a parliamentary committee last week, banks such as his are “prisoner[s] of the market” when it comes to bonuses. But the argument is double-edged.

Suppose the market has in that respect gone insane. Who is to rescue the banks from their mad jailer if not the regulators?

Combine all that with the startling profits now being reported by the big banks, and the mixture is explosive. As Andrew Smithers of Smithers & Co remarks, bankers seem genuinely to believe those profits are the product of their own efforts rather than subsidy by taxpayers and governments.

That arrogance makes them bad at presenting their own case or warning shareholders what might lie ahead. So as new regulations are brought in, “they will come as a shock to management and investors”.
What regulations precisely? They focus on two issues, capital and liquidity.

The Basel Committee proposes not only higher levels of risk-adjusted capital, but also a US-style measure of overall leverage – the idea being that whereas banks previously managed to get round either constraint, it should be harder to get round both. As for a capital or liquidity surcharge for systemically important banks, it is still “evaluating the pros and cons”.

On liquidity, banks should hold enough highly liquid assets to withstand 30 days of cash outflow in a crisis.

The latter would involve – for instance – a run on deposits and being shut off from wholesale funding.

All that costs money – an essential point. But first, note one more proposal bearing directly on bonuses.

Banks should be required to hold a minimum amount of capital. If the level falls towards that amount, distributions should be restricted. For illustration, says the Committee, if the ceiling above the minimum fell as low as 25 per cent, they might be barred from paying out any of the following year’s earnings in bonuses, dividends or buy-backs.

At present, the market seems fairly relaxed about the odds of all that happening. After all, if the Committee is preparing to haggle it makes sense to pitch its opening demands high.

And as one senior analyst put it to me, the politicians may resist after all. The last thing they want is for the cost of all this to jeopardise recovery by choking off bank lending.

Remember too, he said, that half the French banks are bust – and that France, as next year’s president of the G20, may fight shy of measures that expose the fact. The US, meanwhile, has yet to shift most of its banks even to Basel II. If it failed to comply with a more onerous Basel III, there would be uproar from its international competitors.

All of which might be true. The fact is that nobody yet knows. But right now, the case for banking as usual looks shakier than at any point in the crisis so far.

Copyright The Financial Times Limited 2010