Last week’s column (The US$6trn time bomb) focused on the huge and worrisome funding mountain that governments, banks and corporates face in 2011 and suggested that some borrowers will come to grief in their attempts to access a buyer’s market.
As the ink was drying on that piece, the Committee of European Banking Supervisors (CEBS) released the widely anticipated results of its European quantitative impact study (EU-QIS) that put some numbers around the capital shortfall using the new, tighter definitions, as well as the gap in the quantum of liquid assets required under the new liquidity rules.
Most media and research coverage of the QIS focused on the magnitude of those gaps in monetary terms and left it at that. None really assessed its magnitude in strategic terms i.e. the impact that Basel III, pending amendments to the Capital Requirements Directive (CRD4, its EU cousin) and other regulatory accoutrements might have on what banks do or how they do it. This is where the real impact of the changes will be felt.
So to the data: applying Basel III standards to 2009 numbers, the 50 participating Group 1 banks in the CEBS survey (i.e. those with more than 3 billion euros in Tier 1 capital) have a capital shortfall of 263 billion euros assuming a minimum Common Equity Tier One (CET1) ratio of 7 percent, Risk-weighted assets rise by 24.5 percent (principally down to charges against counterparty credit risk, securitisation and new capital standards). As a result, Group 1 capital ratios fall from 10.7 percent to 4.9 percent, against a CET1 minimum of 4.5 percent by 2015 and a supplementary 2.5 percent capital conservation buffer, to be in place by 2019. (On a global basis, the Basel Committee’s study revealed a shortfall of 577 billion euros of capital for the world’s top 94 internationally active banks).
Using the standard 30-day liquidity coverage ratio (LCR), which was put in place to ensure banks have sufficient high-quality liquid assets to withstand a stressed 30-day funding scenario, the banks in the CEBS sample had a (somewhat qualified) one trillion euro shortfall.
CEBS acknowledged that its study was purely quantitative (the title’s a bit of a give-away); the committee made no attempt to remodel the results on the back of the fairly dramatic changes most of the major banks have adopted, are adopting and will adopt in terms of business selection or risk management between the time the new rules were first enunciated and the deadline for full implementation.
In that respect, the numbers, while headline-grabbing, don’t tell the story. While there’s every reason to believe the new capital requirements being imposed on the banking and securities sector will materially reduce the risk of a global financial crisis being unleashed for the same reasons as the 2007-08 crisis; at this juncture it’s harder to get a sense of what the real legacy of the more scrutinous, overbearing and dictatorial regulatory thrust will be.
The likelihood of another crisis emerging for the same reasons as before is pretty remote; chances are that when - and it is when, not if - another crisis emerges, it will be for very different reasons. What’s far more interesting is the fact that the new rules are starting to alter the DNA of the current investment banking and securities business model. This throws up a series of complex challenges.
Regulating, supervising and tracking sophisticated financial institutions, and generally keeping them in check, has always been a hiding to nothing for financial policemen, who have always been a couple of steps behind. In attempting to lead the future of the industry by diktat in this novel juxtaposition of roles, regulators have been propelled into the potentially undesirable position of drafting the financial version of the laws of unintended consequences.
The Danes are complaining bitterly, for example, that the new liquidity rules will in effect destroy the country’s efficient and very large covered bond market. Ane Arnth Jensen, director of the Association of Danish Mortgage Banks said it was almost impossible to see how the financial system as we know it will continue to function. The ’as we know it’ bit gets to the heart of the issue. One thing’s for certain: the investment banking and securities industry will develop new standards that may bear little resemblance to what came before.
Attempting to come up with a regulatory framework today that’s appropriate for the future shape of the industry - and let’s not forget that it’s an industry with some of the sharpest financial, legal, accounting, strategic and tactical brains around which are fully focused on avoiding regulatory control - is a bit like trying to work out the net present value of a complex future quantity with a broken calculator.
Lawmakers have adopted an, in their view, mutatis mutandis approach to the regulation of sophisticated financial institutions, but to stretch the meaning a tad, they are into the bargain unleashing a mutation of a model they failed to grasp or control in the first place. They should have stayed closer to the tenet of abusus non tollit usum: (i.e. just because something is misused doesn’t mean it can’t be used correctly) and taken a less fundamental line of attack.