Surface Ripples

The Cost of Capital

Discussions are now under way to make "systemically important" banks hold more capital as a cushion against losses in another financial crisis. What does this mean?

The question of capital has been raging since the beginnings of the current recession - the idea being that banks should hold more capital to cover losses during bad times. Having plenty of reserves to tide one over in times of crisis is common sense, but will the proposals in their current form create an "unlevel playing field"?

The main "targets" of this would be the large international banks which have multiple lines of business (retail, corporate, investment banking). If the cost of their continuing to do business was to increase, the effect would be either to see them pass this cost on to customers, or to absorb it if they could, or perhaps a combination of the two. Whatever happened, it would result in them being less competitive and/or profitable than their smaller rivals.

The target is the investment banking business which is generally the one that tends to make huge profits (and equally huge losses) so the only other option is to spin off the investment banking arm and capitalise that separately. However, the "cross-subsidisation" of invesment banks by their commercial arms has been one of the reasons banks have been profitable. Remove this profitability and (apart from hefty bonuses) you risk removing/reducing:

- Tax revenues to the exchequer;
- Sponsorship of sporting and cultural events;
- Finance to needy businesses at competitive prices;
- Dividend streams to pension funds;
- Jobs as customers desert to "cheaper" rivals.

There is no easy answer, but should we be making our banking industry less competitive at a time when we need it most? Discipline those likely to cause problems again, rather than punishing the industry as a whole for the misdeeds of the minority.

Labels: Regulation

posted by William Martin @ 16:26