Saturday, October 13, 2012

Lord Turner: UK banks need a capital boost

Lord Turner, the chairman of the UK's Financial Services Administration, observed that if he could redo any one policy response to the financial crisis in 2008, the one thing he would have done is make the banks raise more capital.

As reported by the Telegraph,

Speaking at a satellite event at the International Monetary Fund (IMF) summit in Tokyo, he claimed that banks still needed urgently to bolster their finances but that there was little prospect of action because the galvanising sense of crisis had passed.
This is a very important point.  By adopting the Japanese Model for handling a bank solvency led financial crisis and protecting bank book capital levels and banker bonuses at all costs, policy makers have managed to let the 'galvanizing sense of crisis pass'.

Their reward for doing so is not an economy that is functioning, but rather one that in the absence of enormous fiscal and monetary stimulus would be spiraling downward.

Everyone recognizes that the economy is dependent on fiscal and monetary stimulus for life support and blames the policy makers.

This is not surprising as there was in 2008 and still continues to be another choice for handling the bank solvency led financial crisis:  the Swedish Model.  Under this model, the banks absorb the losses on the excess debt in the financial system and the real economy and society are protected.

The problem the policy makers now face is how to admit they were wrong to have adopted the Japanese Model and change to the Swedish Model without the 'galvanizing sense of crisis'.

Fortunately, or maybe unfortunately, the financial crisis isn't over and the chances of a major flare-up that renews the 'galvanizing sense of crisis' is quite high.
“If I could roll back to 2008 and know then what I know now, I would have argued for us to do a more dramatic ­recapitalisation of our banks. I would have got them up to the [new regulatory level] plus the cyclical capital buffer,” he said. “It is difficult to do except in the teeth of a crisis.”....
Regular readers know that a modern banking system is designed so that governments do not have to bailout their banks.

Banks can operate for years supporting the real economy with low or even negative book capital levels because of deposit insurance and access to central bank funding.  Deposit insurance explicitly makes the taxpayers a bank's silent equity partner during periods when the bank has low or negative book capital levels.
Lord Turner said fixing the banking system now “could further depress nominal demand and activity in the short term”, hindering efforts to get the economy on track by deterring bank lending. 
One solution, he said, would be to “cut through” the problem by “engineering rapid increases in bank capital”. The way to do that, he suggested, would be to force banks to raise more capital and to “provide a public backstop if banks were unable to [get it] from private sources”. 
However, he admitted that it would now be difficult politically to justify more taxpayer money for the banks....
Actually, the banking system could be easily fixed now by adopting the Swedish Model with ultra transparency.

By having the banks absorb all the losses on the excess debt in the financial system, the debt service burden of this debt is lifted from the real economy.  As a result, the real economy can use the freed up cash flow for reinvestment or growth.

As for lending, for the last 3 decades it has been independent of bank book capital levels.  Origination of the loan is separate from funding of the loan which can be provided by other market participants including, but not limited to, banks, pension funds and insurance companies.

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