Time to let some air out of the banking system?

Since 2008 – when global banking went ‘pop!’ – regulators have been trying to ensure the reinflation of capital in the system. But now, with global policy-makers desperate to boost their economies, Europe, for one, is considering whether to stop pumping up capital – and maybe let some air out.Since most banks have withstood a string of more recent crises, there’s evidence to suggest current capital levels are adequate. Regulators have unfailingly praised banks for being “a part of the solution” to the economic turmoil resulting from the Covid-19 pandemic. In the fallout from the Ukraine invasion, only Russian banks were seriously wounded. And despite repeated wild swings in energy markets, banks have come through with the mere scratches of credit and market risk losses.But there are two major exceptions to this testimony to resilience. The first is Credit Suisse. With its strong capital levels, the group’s 2023 collapse took many by surprise. The bank suffered a complete loss of confidence when management blunders exacerbated losses inflicted by the collapse of Greensill and Archegos. Doubting its safety, depositors withdrew their money en masse.Some regulators point to developing vulnerabilities as the reason capital standards should not dilute – and should strengthen even furtherPerhaps a stronger capital position could have persuaded them otherwise. But it seems unlikely.Which hints at the potential pointlessness of raising capital further. The other major exception is the string of US regional banks that failed that year and set in train the banking crisis that led to the Swiss bank’s demise. Silicon Valley Bank is often seen as the unfortunate poster child of this regional bank crisis.Some US regulators say capital wasn’t the issue in SVB’s failure. Rather, it was its liquidity profile. Along with poor interest rate risk management, the bank couldn’t monetise its assets quickly enough to repay fleeing depositors.And this isn’t the full picture. SVB’s capital levels proved inadequate because they didn’t reflect the risks in its bond portfolio. US regulators are partially solving this problem by removing from the calculation of capital requirements a filter that essentially turned a blind eye to unrealised losses in bond portfolios. Nonetheless, the fix won’t capture similar types of loss found elsewhere in banks’ books – the same ones blamed for SVB’s insolvency.This panic spread to the health of US regional banks generally, and two further banks failed. Yet US regulators’ fix hands a 3–8% capital reduction to regional banks. The rejig shows how capital standards can account for missing risks while being weaker overall.Reducing capital levels is a surprising response to widespread panic.Global stability, meanwhile, is in short supply. Some regulators point to developing vulnerabilities as the reason capital standards should not dilute – and should strengthen even further.The argument for preserving or building resilience could prove to be a wise one. Geopolitical instability means conflict is more likely. Populism’s rise could lead to naive political decisions, which ultimately harm societies and their economies. Some left-field political and economic decisions in the US – and in the UK – in recent years bear witness to this. Artificial intelligence companies portend the ability to destroy humanity – while sitting on a mountain of debt.Sovereign bond markets are frequently shaken by investor doubts of governments’ abilities to repay their debt. The recent wild gyrations in the French government bond market are just one reminder of this.With all these clear and present dangers, now might be the worst time to relax bank capital requirements – unless it provides a solution to one of these risks. If freeing up capital leads to more growth, tax revenues should rise and alleviate government debt burdens. And averting a major fiscal crisis could protect the banking system.Policy-makers must weigh their decisions carefully.Editing by Louise Marshall Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe You are currently unable to print this content. Please contact info@risk.net to find out more. You are currently unable to copy this content. Please contact info@risk.net to find out more. Copyright Infopro Digital Limited. All rights reserved.You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.If you would like to purchase additional rights please email info@risk.net