Over the weekend it was announced that global banking regulators had finally agree to new capital standards for banks. The standards were coordinated by the Basel Committee on Banking Supervision. In short, banks are going to be required to have more capital (read: equity) on hand relative to the amount of leverage (read: debt and other investments) on their balance sheets.
These new regulations are to be phased in over the next eight years. The reason for the slow implementation is to make sure that banks are able to provide the economy with money during the nascent worldwide economic recovery.
Analysis: These new standards promise to make sure that banks conduct business more conservatively and reduce the risk of future bank failures. I am a big fan of conservative banking and aggressive investment banking. Consequently, I am delighted that globally banking is going to be required to be conducted with more prudence. The wall that used to exist between commercial and investment banking was eliminated in the late 1990s and it took less than a decade for banks to create financial chaos and near ruin in the same manner that they did in the 1920s that helped contribute to the Great Depression and that led to the creation of those regulations in the first place.
It is likely that these regulations will lower the profits of big banks. However, managing any portfolio of assets, whether it is General Motors or Bank of America, has two important foci: return (i.e. profits) and risk (i.e. sustainability of profits). So while net income may be lower going forward, it is also likely that net income has a greater chance of sustainability because of these standards. This is an excellent outcome.
Expect the big banks around the world to protest the new regulations. The typical fear-based mantra is that borrowing costs for Auntie Emma will rise and that she won’t be able to afford to buy a house. This is nonsense. The financial crisis of the last two years is much more detrimental to Auntie Emma’s lifestyle than the fact that her mortgage rate might be 0.5% higher than previously. Isn’t this patently obvious?
What you can expect, fear-mongering aside, is a more consistent, more stable, less leveraged economy. These standards will affect just about every money transaction going forward, ranging from your ATM withdrawal fees to the cost of debt for a big commercial real estate development. These far-reaching effects are the equivalent of a doctor insisting her patient eat the best foods to maintain a healthy weight. And for that we should all be grateful.
Importance grade: 10; for two years now I have been saying on this blog that it was important to exit this recession having changed the things that led to the recession in the first place. A restoration of saner capital requirements at banks was an extremely important part of that. Amen!
Jason
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