Is it a “watershed moment” in ending the problem of banks being too big to fail? That was the boast of the Bank of England governor, wearing his international hat of chair of the Financial Stability Board.
In a sense, Mark Carney is right. More than half a decade after the failure of Lehman Brothers and the state-sponsored rescue of Royal Bank of Scotland, financial regulators have finally stated how big capital buffers should be to avoid the need for taxpayers to write a large cheque in the next crisis. That is definitely progress.
The technical answer is that banks’ loss-absorbing capacity should be 16-20% of assets, adjusted for risk. Throw in other capital buffers imposed nationally and the real range might be 21-25%.
The thinking here is hard to dispute. In 2007-09, capital buffers were so low they were a joke. It is clearly sensible to force the likes of RBS, HSBC, Barclays and Standard Chartered – the UK brethren affected by the new rules – to be able to absorb much bigger losses.
There is a price to pay in terms of banks’ higher funding costs, which will inevitably be passed on to customers, but so be it. The alternative was the current system whereby the biggest banks enjoy, in effect, a state subsidy. That is bad for competition and stability, as well as taxpayers.
The difficulty lies in believing that, in a true crisis, governments would hold their nerve. For a crisis engulfing a single bank, it would not be hard to burn a few bondholders. But what if several global banks were on the brink at the same time? Would governments really allow bondholders’ losses to ricochet through the financial system and across borders? Or would national self-interest trump sensible coordination? It is impossible to say until the next crisis plays out.
So, yes, it is indeed a watershed moment for the regulators to have a plan for battle. By definition, though, financial crises occur out of the blue when regulators have been taken by surprise, or have been asleep. Judge the success of these bigger buffers only when they have been tested by events.
