Page 15 - Monocle Quarterly Journal Vol 1 Issue 1 Q4

Banking and the Shackles of the Capital Ratio
BY DAVID BUCKHAM
In an online chat group that tracks the banking sector, in a con- versation over the poor performance of European banks in the recent stress tests, I was stunned to come across a comment from a
contributor who asked the following question: “Can somebody explain me (sic) why it is in the interest of overall society that banks have capital levels to withstand even the worst crisis?”
To many, the question must seem borderline subversive. In a post-Crisis world in which taxpayers were forced to bail out the banks, questions like these are generally deemed in ammatory and irresponsible. But the truth is that it is a very good question.
Putting aside any political distaste for the banking industry, the logic behind the question is sound. In signi cantly raising what is known as the CET1 ratio – the ratio between common equity Tier-1 capital and total assets – the Basel regulator has inadvertently radically increased the likehood of failure in banking.
ink about it rstly at a systemic level. Requiring all banks to hold more capital means a less attractive banking sector overall from an investment perspective. Increased capital means lower returns on equity, which means lower returns to shareholders. It is therefore increasingly di cult for banks to attract new capital, requiring them to hold back dividends or to issue rights that dilute existing investors.
Banks, however, will nd little empathy from the public based on this argument. It is only when one looks at the problem of capital at the idiosyncratic risk level, that the chat room contributor’s question becomes more compelling. At an idiosyncratic, individual bank level, the increase in the CET1 ratio has meant that banks have become more risky, rather than less risky.
To explain: recall that Lehman Brothers was not the only institution that was holding large volumes of very poorly performing assets – parti-
“Requiring all banks to hold more capital means a less attractive banking sector overall from an investment perspective.”
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