Sunday, November 10, 2013

Banks will benefit from more capital, not less

Banks in the western world have been crying themselves hoarse over the increase in bank capital mandated under Basel 3. They say higher capital will mean costlier lending, it will cause banks to cut back on asset growth or even shrink assets. One way or another, they say, it will end up hurting the economy.

Worse, higher capital risks causing an erosion in investor interest in banks. Who would want to invest in the face of falling return on equity?

Well, the reality is that banks in the US have moved to meet the higher Basel 3 requirements well ahead of the deadline of 2019. And with what result?Their share prices are soaring. Swedish regulators have mandated a tier I capital ratio of 12%, way above the 7% mandated by the regulators. And Sweden's banks are producing a return on equity of 15% compared to 10-12% produced by their better known European counterparts.

How do you end up increasing return on equity with greater capital? Well, you get the benefit of cheaper borrowings. As for share prices, the markets end up giving a higher price to earnings (or book) multiple because they see banks with higher capital as being safer. Here's the bottom line: don't try to keep bank capital down to the regulatory minimum or even lower based on your own risk modelling. Hold capital more than what regulators require. After the financial crisis, the advantage lies squarely with banks with more capital, not less.

Read this excerpt from an article in FT:
Here is the problem: banks have spent a lot of time, energy and money warning of the potential ill-effects of ramping up regulation. But since the crisis, international regulators have kept demanding more capital, including a surcharge for the biggest banks. Lenders have doubled their capital levels as a result, hitting the new Basel III targets six years early in some cases and, yet, where are the ill effects? The best of them continue to set new profit records.

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