A top US regulator takes the drastic step of suspending bank capital requirements. The global crisis is so bleak that the Federal Deposit Insurance Corporation says the country needs banks to focus on lending rather than the additional stability of higher capital.
“The question,” according to the FDIC, “is not whether a bank has enough capital for the type of assets which it now holds and the risks which it now appears to face, but whether it has enough capital to enable it to assume the proper and reasonable risks of participating in the financing of business enterprise.”
But before Brian Moynihan of Bank of America and his fellow chief executives pop the champagne corks, I have a clarification. Although the passage is from the FDIC, I stumbled across it in the FT archives, and it comes from 1944.
Today’s regulators are more hawkish. With memories of the 2008 crisis still fresh, banks round the world have been ordered to achieve a 7 per cent ratio of core capital to risk-weighted assets by 2019 as part of the Basel III reforms. The largest must reach 9.5 per cent. With European banks still too feeble to withstand sovereign defaults, they are being instructed to accelerate capital building .
How they do this will prove increasingly controversial. Anders Borg, Swedish finance minister, said at the weekend that “the first solution [should be] withholding dividends and tapping profits”. Others in his camp say raising capital in the market should be the second solution.
If policymakers want banks to raise fresh capital they are going to have to force it to happen and police it vigorously. With the share prices of the largest international banks down 30-60 per cent this year, chief executives are reluctant to inflict more pain on long-suffering shareholders (including themselves) by diluting them in an equity raising. Even Mr Moynihan, whose bank is seen as the weakest of the top five in the US, has ruled that out.
At the same time, fearful of losing top staff, banks are still preparing to pay out about 40 per cent of their revenues in salaries and bonuses this year. And the Federal Reserve has allowed most large US banks to increase their dividend pay-outs and share buy-backs, cutting the amount available to build up capital.
With this set of instructions and incentives the banks are going to do precisely what the wartime FDIC wanted to avoid: solution three – cut the size of their balance sheets , further reducing credit to a battered economy.
But there is a fourth solution that has received limited attention yet may prove crucial: magical Alice in Wonderland tricks of financial innovation. Rather than increase the numerator of the capital ratio by hurting shareholders and employees or reduce the denominator by hurting businesses and customers, bankers are quietly getting creative once more.
The opportunity comes because of regulators’ decision to calculate capital rules using risk-weighted assets rather than total assets. So the safest securities, such as US Treasuries, do not count as assets at all for the ratio, but the riskiest – such as long-term structured credit assets – count at double their stated value or more.
Jamie Dimon, JPMorgan’s chief executive, said last week that he intended to “manage the hell out of RWA” to reach the higher levels. Morgan Stanley revealed that its risk-weighted assets had ballooned by $44bn after the Fed said the bank was managing the hell out of its assets too much and told it to stop.
A senior executive at a third bank told me that it was scouring its balance sheet, looking for assets that could be structured differently to achieve lower risk weights. And, as the FT reported this week, hedge funds and insurers are actively involved behind the scenes, seeking new structures to buy or guarantee a slice of risk on banks’ books.
So by financial alchemy, assets can be transmuted from garbage to gold – and, therefore, require less capital. A senior regulator tells me officials are fully expecting various nefarious schemes to circumvent the rules, including structured transactions that do not reduce their risk but do reduce their RWA.
This is arcane stuff and it can easily be lost in the headlines of whether Basel III is “anti-American” , as Mr Dimon has said, or anti-European. Meanwhile, regulators are all suspicious of each other – countries that adhere to the 1944 view of the world could be lenient on their banks just by turning a blind eye to risk-weight manipulation.
Whether you call it gaming the system or legitimate management, the capital hawks will need to watch both the banks and the national regulators if RWA is not to mean Really Weird Accounting.
Tom Braithwaite is the Financial Times’s US Banking Editor
tom.braithwaite@ft.com