Wednesday, May 2, 2012

Ignoring Basel III key to EU ending financial crisis

UK Chancellor George Osborne confirmed why the EU's ignoring Basel III is key to ending the financial crisis.

According to a Telegraph article,

George Osborne ... told European finance ministers that the EU needed to show the world it had sorted out its banks. 
"If we duck the challenge of implementing Basel we could face very important challenges to confidence in Europe this year," the Chancellor said. 
"We certainly won't fool the financial markets, who will continue to be wary of investing in Europe and investing in European banks....
The financial markets are not fooled by the current condition of European banks.  They understand that the banks are insolvent (the market value of their assets is less than the book value of their liabilities).

These banks have been insolvent since the beginning of the financial crisis.

Furthermore, the market is not fooled by the focus on capital.  As the OECD said, bank book capital and capital ratios are 'meaningless'.  

There are several factors that contribute to why bank book capital and capital ratios are meaningless including suspension of mark-to-market accounting and adoption of regulatory forbearance.

Finally, the market has already shown that it is wary of investing in Europe or in European banks so long as policymakers continue to pursue higher capital levels prior to the recognition of bad debt hidden on and off the bank balance sheets.

Confirmation of this fact comes by simply looking at how the market is staying away from European banks despite the current financial regulators' mandate that banks achieve a 9% Tier I capital ratio.
As well as being an issue of prudential rules, the question is seen by Britain as a national sovereignty issue, a protection for taxpayers who would be forced to bail out a bank that failed due to capital requirements being set too low.
"National taxpayers have to underwrite banks so it should be a national decision," said a British official....
Actually, national taxpayers do not have to underwrite banks in a modern banking system.  Banks are perfectly capable of absorbing today all the losses on the excesses in the financial system without being bailed out.

By absorbing these losses, the banks would take the burden of bad debt off of the real economy and let the EU recover.

Given deposit insurance and access to funds from the central bank, banks have the ability to continue operating and supporting the real economy while they repair their balance sheets by retaining future earnings.
The so-called "Basel III" agreement was agreed by the world's leading economies after the 2008 financial crisis showed many banks did not have enough of a capital cushion to absorb sudden losses on loans.
The simple fact is that banks have virtually unlimited capital and therefore can absorb all the losses in the financial system.  They have what is on their balance sheets today and what they can earn in the future. 

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