As the world’s banking system teetered on the brink of collapse just about a year ago, there were widespread, heartfelt, calls for reform.
Politicians of all stripes on both sides of the Atlantic, spurred on by taxpayers’ outrage at the cost of bailing out those who ought to need help least, vowed to get tough. No longer would banks be allowed to become too big to fail, or bankers be rewarded for taking risks that prove the undoing of their institutions.
But just one year later, as the world’s economy begins to emerge from a severe recession and some big banks once again appear profitable, it is not clear that the political resolve remains as strong.
To this end G20 finance ministers, meeting in London, agreed the broad outlines of a future regulatory structure designed to ensure that banks cannot take risks they do not understand or offer senior employees rich rewards for activities that, years later, prove the system’s undoing.
“We cannot put the world in the position where things go back to where they were at the height of the boom,” Tim Geithner, the US Treasury secretary, said at that meeting.
But, already, things appear to be heading that way. In the US, a newly emboldened banking sector has succeeded in beating back modest initiatives to alter rules allowing bankrupt homeowners to remain in their homes. It is also making fierce headway against a new consumer protection agency for the financial sector and is pushing back hard against efforts to force OTC derivatives trading to go through clearing houses to limit the counterparty risk.
Of those three initiatives, only the last is directly relevant to the international banking community, but banks’ successful efforts illustrate starkly the gap between what regulators say needs to be done and what is likely to happen on the bank supervision front.
Ahead of the G20 summit, both in backroom meetings and in public arenas, French and German finance ministers pressed for specific limits on bankers’ bonuses, measures neither the US or the UK could endorse. The US, having seen the dismal failure of efforts to cap executive pay more than a decade ago, urged another approach, seconded by the UK.
The group agreed a set of principles on bonuses that stop short of full caps but which require a substantial percentage to be deferred, available for clawback should activities that looked profitable in one year go badly wrong. It also agreed that bank regulators in each country should be able to veto the overall size of the bonus pool, should it prove too big relative to the risks posed by each institution. The Financial Stability Forum group of finance ministers and supervisors was asked to come up with specific rules for bonuses by the time of the Pittsburgh G20 summit last month.
Alistair Darling, UK chancellor, sought to underplay differences between countries on bonuses, describing these as “a symptom” of the problem, not the core issue.
Indeed, at the heart of the broad reforms agreed by G20 finance ministers are elements that, when added together, make risk-taking by financial institutions much more expensive. In theory, that should make banks less able to pay big bonuses for taking risk in the first place.
These include requirements for more, and higher-quality, capital to be held by banks “once recovery is assured” and the introduction of countercyclical buffers so that banks set aside more reserves in good times to be drawn upon in bad.
In particular, it will require systemically significant financial institutions – those whose failure could pose a risk to the entire system – to hold more capital than others. “Capital is a shock absorber for the future,” Mr Geithner says.
One of the more controversial proposals – not fleshed out fully in the G20 statement but also discussed in a concurrent statement from the Basel Committee on Banking Supervision – calls for an overall leverage ratio, setting out the maximum borrowing a bank can have relative to the capital base.
In an eight-point plan issued just before the meeting, Mr Geithner made clear that the ratio should apply not just to the banking business of each institution but across all its entities, and would apply regardless of the risks posed by the assets the bank held. This sparked finger-pointing from some European officials who said that US banks have an edge because they already operate under such ratios.
But US institutions will also find institution-wide leverage ratios tough; currently, these apply only to entities included on bank balance sheets. Off-balance-sheet vehicles such as structured investment vehicles were not included – one reason why banks had so little capital to shield them from their losses.
But continental banks, weaned on capital requirements that fell and rose with the riskiness of assets they held – explaining why these invested so heavily in AAA-rated mortgage-backed securities and collateralised debt obligations – were fighting back behind the scenes, arguing that the US, which has never signed up to the Basel II agreement on capital, do so forthwith.
Mr Geithner pledged that the US would sign up to a new and improved “Basel III” that all banks will be asked to agree on.
But even that is unlikely to see a new regulatory regime through. First, it is likely that any element of the new, tougher regime will face pushback from the banking community and, in the US, from their supporters in Congress who receive substantial campaign contributions from the industry.
British bankers, for their part, are not far behind, with the British Bankers’ Association arguing that they cannot raise new capital and step up lending to households and businesses at the same time. This is despite the fact that the G20 statement makes clear that the rules can wait until the current recession is over.
In short, an overhaul of international standards of bank regulation remains a clear but highly uncertain goal.
It involves curbs on enormously wealthy individuals and institutions whose political influence appears as strong as it was before the credit crisis hit in 2007. Regulation will affect businesses that provide billions in tax revenue and employ significant swathes of workers.
But Mr Geithner has an answer for those who argue that regulatory reforms will make banks less profitable, to the detriment of all.
“These banks,” he says, “created a misleading impression of profits.” In other words the banks, thanks to accounting rules and other regulations, were never as profitable as they appeared.