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Sighs of relief heard from the bankers' bunkers

By Adam Creighton - posted Tuesday, 20 September 2011

Banks might have feared big changes after the global financial crisis. Millions around the world were thrown out of work as bankers pocketed pay that would make Croesus blush.

Taxpayers were shackled with world war-debt levels as governments rescued, even bought, banks deemed ''too big to fail''. The convenient fiction that banks competed at arm's length from government, subject to the bracing rigours of capitalism, was shattered.

In fact, what played out - privatisation of profits and socialisation of losses - was a gross perversion of capitalism.


The Basel Committee on Banking Supervision, the international forum of bank regulators whose risk-management standards facilitated the disaster, retreated to Switzerland in deep introspection.

In December, it emerged with Basel III, a new set of ''tough'' rules that update Basel II, itself a new rule book that was being bedded down as the financial crisis got under way in 2007.

The minimum capital ratio (which affects the mandatory gap between banks' total assets and liabilities) would remain 8 per cent of risk-weighted assets. But the quality of its components would increase. Moreover, a new ''leverage ratio'' would limit banks' assets to 33 times (!) the value of their capital. Regulators would also get more discretion to bolster minimum requirements.

If that were not tough enough, full implementation would occur before 2019. It was as ferocious as unleashing a pack of poodles on a herd of elephants. Sighs of relief in Wall Street, Canary Wharf and Martin Place, where banks are already close to satisfying the new requirements, were almost audible.

Britain before the GFC was like an island hedge fund gone hopelessly long on financial services. It has suffered more than most countries - its public debt has surged more than 25 percentage points, or £400 billion ($A615 billion), to 85 per cent of national income.

Sir John Vickers, an Oxford don and former chief economist of the Bank of England, was commissioned last June to investigate how to make Britain's banks more robust and curtail the implicit subsidy taxpayers had been providing - a ''free'' subsidy estimated to be at least £10 billion a year, equivalent of the total annual profits of a handful of major banks.


The commission's findings, released this week, did not mince words. It thought Basel III "insufficient, albeit a major improvement", and argued "massive enhancement is needed". It's not hard to understand why.

The Basel III minimum capital ratio of 8 per cent, of which only a bit over half has to be ''cash under the bed'', is calculated as a proportion of ''risk-weighted'' assets. That's typically half the measured value of bank assets, so ''real'' capital ratios are closer to a handful of percentage points. Imagine being insolvent if your share portfolio dropped a few per cent. Moreover, risk weights themselves are arbitrary, clunky, and ripe for bank manipulation.

By contrast, Sir John's commission estimated that capital ratios of between 16 per cent and 24 per cent would have been enough to protect hapless taxpayers from forking out billions to prop up creditors, ''bonuses'' and shareholders. It would have largely excised the ''too big to fail'' problem.

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This article was first published in The Age on September 16, 2011.

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About the Author

Adam Creighton is a Research Fellow at the Centre for Independent Studies.

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