Thursday, November 10, 2011

Regulators further damage real economy with focus on meaningless Tier 1 capital ratio

According to an article in the Telegraph, Lord Turner, the head of the FSA, said there is nothing that regulators can do if banks elect to meet the 9% Tier 1 capital ratio by cutting back lending and shrinking their loan portfolio.

As OECD’s Blundell-Wignall said
The core Tier 1 ratio is a ratio of two meaningless numbers, which itself is a meaningless number because banks can alter the ratio themselves.
Lord Turner confirms that the result of pursuing a meaningless number is damage to the real economy.
[T]he "tools" available to the regulator where "somewhat limited" and that if lenders opted to call in loans to help them hit the new targets that was not something the authorities would be able to prevent. 
... corporate lending could suffer as banks face the choice of either raising new capital or cutting back the size of their balance sheets. 
Lord Turner said he would prefer the deleveraging took place through cut-backs in the banks' trading activities, rather than scaling back their lending activities. 
The FSA chairman said that higher capital requirements on trading businesses might be needed to discourage risky trading. 
"We do have to decide whether we have got the capital rates right for interbank activity, for trading activity," he said.
Actually, requiring the banks to disclose their current asset, liability and off-balance sheet exposure detail would be far more effective at shrinking the trading book than higher capital requirements.

If all market participants can see the bank's positions, they will tend to eliminate all positions that are not absolutely necessary for their market making function as market participants will pressure the banks to reduce their risk profiles.

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