Coming up for half a decade on from the worst of the financial crisis, efforts at strengthening the regulation of banks are still moving at a snail's pace, not least because the bankers are fighting the regulators at every turn. The Toronto Star's David Olive has a column in today's paper that tries to argue that the entire basis of most regulatory reform proposals is fundamentally misguided. Most of Olive's arguments are lifted wholesale from this much more tightly-reasoned piece by Matt Yglesias on Slate, which is in turn based on a recent book, The bankers' new clothes, by Anat Admati and Martin Hellwig*.
Rather than busting up excessively large banks or separating "utility" banking from more speculative activities, Admati and Hellwig (and hence Yglesias and Olive) believe that the real solution involves forcing banks to maintain much more capital as a cushion against losses. They suggest a capital ratio of 20-30%, which is about twice as much as even the best-capitalised banks currently maintain, and much higher than the target capital ratios that the Basel III guidelines aim to achieve by the end of the current decade.
I haven't read Admati and Hellwig's book, but I strongly suspect that David Olive's take on their ideas does not do them justice. Olive seems to believe that it would be very simple to get bank shareholders to pony up more cash, even while curbing dividend payouts (he appears to think that retained earnings are free money) and curbing the banks' riskier (but also more profitable) activities.
It seems highly unlikely that this would be true. Nobody has to own bank shares; skewing the risk/reward ratio so markedly against the equity holders would make it difficult and expensive to attract the extra capital that the banks would be required to hold. Olive doesn't seem to see this at all; Yglesias does, and acknowledges that it would "give a different shape to the real economy" by making borrowing more expensive for some (consumers, small businesses) but cheaper for others (governments, corporates). Yglesias may well be right about this, but the dislocation involved in getting from here to there, so to speak, may well be enough to deter regulators from adopting Admati and Hellwig's ideas.
I found myself a bit puzzled when reading David Olive's take on all this, because Canada avoided the worst of the financial crisis, and its banking system is seen as one of the safest in the world. I became even more puzzled when I started to look at some of the numbers Olive tosses about regarding banks' current capitalisation, numbers which seem to be the product of his own "research".
Olive says that banks maintain "microscopic" capital ratios of only 3%, and that rather than retaining earnings, they blow them out to shareholders, mainly in order to boost the share price, on which (he asserts) management's compensation is based. They then make up for the lack of capital by borrowing too much.
I just took a look at the 2012 annual report and Q1 quarterly statement for my old alma mater, TD Bank Group. Admittedly TD is an exceptionally well-run bank, but it's not atypical within the Canadian financial system -- and its numbers bear no resemblance whatever to those Olive is throwing around. Capital ratios? TD's Tier 1 ratio is 10.9% and its total capital ratio is 14.2%, far above the 3% that Olive seems to have grabbed out of thin air. Retained earnings? Well, of the C$ 6.4 billion in "income attributable to shareholders" earned by TD in 2012, only $2.6 billion was paid out in dividends. The rest, $3.8 billion or 60% of the total, was added to capital as retained earnings. Too much debt? TD's equity at book value stood at $47.5 billion at the end of fiscal 2012, against $11.3 billion in subordinated notes and debentures -- and that debt total, by the way, has been falling steadily in recent years.
There's a strong case to be made for tighter regulation of banks, but it's not helped by columnists inventing numbers in a crazed effort to show how bad the current situation is. That just makes it easier for the banks to push back. I'd be very surprised if David Olive doesn't find a stack of messages on his Blackberry from the CFOs of the big Canadian banks, looking to set him straight on a few things.
* I'm not accusing anyone of plagiarism -- credit is given where credit is due by both Olive and Yglesias.
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