The glories of financial regulation

The financial regulators still seem to be ignorant of the fact that you cannot have both higher capital requirements for banks and also an expansion of bank lending.

Ever more onerous capital and liquidity requirements have steepened the refinancing challenge, even with highly supportive central bank funding on hand.

European banks, still grappling with high leverage and a worsening sovereign debt crisis, are particularly badly affected. Because of the escalating European banking crisis, they face intense pressure to meet new capital and liquidity requirements more quickly. With new equity virtually impossible to raise, this has only further exaggerated the de-leveraging problem.

It gets worse too:

You might think this a significant growth opportunity, but Mr Barnier\’s new solvency directive threatens to snuff that one out too, by requiring that only the most credit worthy and liquid bonds count for capital purposes.

The new solvency requirements virtually outlaw bundling together corporate loans and issuing them as asset backed securities, or rather, they prevent financial institutions from providing a viable source of demand for such bonds. Instead, finance is pushed by regulation ever more aggressively into sovereign bonds, even though many of them are now less than credit worthy.

The rules also threaten to stymie Government hopes of the private sector substituting for the public infrastructure spending being cut as part of the austerity drive. Many long dated infrastructure bonds don\’t meet the investment grade deemed necessary to qualify as a \”safe\” investments for insurers.

And doesn\’t that just stuff Ritchie\’s plan for infrastructure bonds?

3 thoughts on “The glories of financial regulation”

  1. We don’t want an expansion of bank lending though do we? That’s what got us into the mess last time. To paraphrase a wise cliche about jobs-

    “borrowing is a cost, not a benefit”


  2. Not just Ritchie’s plan. The Government’s plan for SME-loan-backed securities too. Thank goodness. Though they will probably produce them anyway then go “oops” and try to force the Bank of England to buy them. Because they’re idiots.

    Though I am amazed that anyone thinks Eurozone sovereign debt is a better risk than corporate bonds. Remarkable.

  3. Offshore Observer

    Frances, when Apple’s cash pile is almost as large as all the deposits in Greek banks I think I know which might be a safer bet.

    Government’s want growth but in the last 10 years we had economic growth through an expansion of credit. If you plot economic growth and credit growth in the US over the past 20 or so years you will see a remarkable correlation. So Tim is absolutely correct it is pretty difficult for the government to want higher economic growth at the same time as imposing regulatory requirements on the financial sector which will reduce the amount of credit in the economy. Moving from Tier 1 core capital of 2-3% of RWA to 7-11% can only be done two ways (1) massive capital raising in an environment when capital is being hoarded or (2) shrink your balance sheet. Is it any wonder that banks are choosing (2).

    Of course there is a theory that debt doesn’t matter as all debt is balanced by an asset on the balance sheet so ultimately leverage doesn’t matter. I think we all agree that is bollocks as the the assets turn out to be valueless.

    The real question which needs some serious thought is how do we have long term economic growth through genuine productivity gains and avoiding simply loading on debt as the solution. And doing that with a demographic shift resulting in a shrinking workforce.

    There is another option which is simply to do what has been done in in the past in Australia, the US and the UK which is simply to allow substantial population growth through immigration. THat might get the economy through the next 10 years and get us out of the current recession, but still is not a long term solution.

    Then again as Keynes said in the long run we are all dead. Perhaps a solution which lasts 3-5 years is long term enough at the moment.

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