The policy of 'What is good for banks is good for the economy' has failed

Over the last 2+ decades, Japan has definitively shown that the policy of 'what is good for banks is good for the economy' has failed.

Regular readers know that under the Japanese model losses on the excesses in the financial system are only recognized as banks generate the capital to absorb them.  This is good for banks because the model involves hiding their true condition and pursuing policies designed to boost bank earnings.  It is bad for the economy because it distorts asset prices and access to capital (for proof, look at the performance of Japan's economy).

The alternative is a Swedish model that is bad for banks and good for the economy.  It is bad for banks because they are required to recognize the losses on the excesses in the financial system today.  It is good for the economy because it avoids the distortion in asset prices and access to funding associated with hiding the losses under the Japanese model (for proof, look at the performance of Sweden's economy).

In a Telegraph article, UBS presents the argument that banks and their investors need regulatory certainty if they are going to safeguard economic growth.

Since the beginning of the financial crisis, your humble blogger has observed that all this regulatory activity  has been a lot of "sound and fury, signifying nothing".  The regulatory activity has been undertaken not to require banks to take losses today, but instead to draw attention away from this fact.

The Swiss investment bank argues that Britain's largest lenders, including state-backed Lloyds Banking Group and Royal Bank of Scotland, have largely met the authorities' risk-reduction goals and that rules forcing them to further shrink their balance sheets will be harmful to the economy. 

"We believe the UK banks would be lending more, and funding more cheaply, if they and their share and bondholders had confidence that today's regulatory agenda was substantially complete," said UBS in a report published on Tuesday.

The regulatory agenda is a red herring.

What investors need is not regulatory certainty but certainty about what they are buying.

The real question is are these banks solvent or not.  If they were required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, market participants would know the answer.

If the banks have really reduced their risk profile and aren't hiding losses, then their funding costs should decline and one could expect that their share price would increase.

UBS points out that after more than £100bn of write-offs, banks today have a combined equity capital £100bn greater than at the time of the financial crisis and a pool of liquid assets to draw on that is more £300bn larger than in 2008.

How does anyone know that the write-offs taken so far are a significant percentage of these banks' exposure to losses from the excesses in the financial system?

Without ultra transparency, it is impossible to tell.

It is this lack of transparency that is one of the reasons that the Japanese model fails.  

"All that is left the same is the names on the doors of the surviving banks," said UBS, which argued that about 95pc of the taxpayers' guarantees and cash support to the banks will be repaid....

"The UK has a banking system with stronger balance sheet metrics as a result. It is just that it is one that is not working for shareholders, and is delivering lending negative growth to the economy."