In the wake of the Great Recession (2007-8) – a crisis largely of the financial system – the multinational Basel Committee and the Group of Central Bank Governors and Heads of Supervision, comprised of central bankers, banking supervisors, and regulators more than doubled the amount of equity (Tier 1) capital banks must have to 4.5%.
Another 2.5% of their assets must be held as an equity “conservation buffer” to be amortized and deployed in case of emergency. Banks which resort to the buffer must, however augment their capital by any (legal) means possible (for instance, by not distributing dividends, by divesting non-core assets, or by issuing new stock). Yet another 1.5% of the balance sheet must be held in “less-than-equity” quality investment vehicles and the total leverage ratio must never go below 3% in equity (admittedly, a liberal number).
Moreover: regulators can impose the equivalent of yet another 2.5% in risk-weighted assets (including off-balance-sheet assets, such as derivatives) in the form of a “countercyclical buffer”. This is intended to counter the pro-cyclical nature of most capital requirements and reserves regimes: the more assets’ prices rise (and commensurate risks increase), the less the capital set aside as loans are deemed “safer” by greedy bankers whose compensation is often tied to their institution’s short-term performance.
The Basel III regime has to be fully implemented by 2019, a concession to under-capitalized banking sectors in various EU members (notably Germany). Ironically, the Basel Committee was created in 1974, following the failure of a German bank and an ensuing near-collapse of the currency markets. Indeed, the Basel regime is as strong as its weakest link: multilateralism has its price. This in-built frailty forces the Committee to remain vague on what constitutes capital; on disclosure regarding derivatives; and on the loaded issue of subordinated debt vs. corporate bonds (subordinated debt would force banks to become a lot more transparent and is likely to foster shareholder activism).
Banks are institutions where miracles happen regularly. We rarely entrust our money to anyone but ourselves – and our banks. Despite a very chequered history of mismanagement, corruption, false promises and representations, delusions and behavioural inconsistency – banks still succeed to motivate us to give them our money. Partly it is the feeling that there is safety in numbers. The fashionable term today is “moral hazard”. The implicit guarantees of the state and of other financial institutions move us to take risks which we would, otherwise, have avoided. Partly it is the sophistication of the banks in marketing and promoting themselves and their products. Glossy brochures, professional computer and video presentations and vast, shrine-like, real estate complexes all serve to enhance the image of the banks as the temples of the new religion of money.