Talk is dirt cheap, and every goes about shoveling it around freely. And inevitably, the most banter comes from large banks that are too large to fail, lest their death creates shock waves among those invested in the banks well-being. Time and again, as banks have started to show signs of dying out, it is the taxpayer who has borne the burden of offering emergency CPR to them. The easy option is to burden the creditors, but that simply has never been done. 2008 was a crazy time, and banks would pass each minute of the day in a cold sweat, not sure if their valuation and share prices would be halved in the next minute.
Naturally, everyone even remotely involved with these banks tried to pull their cash out of the system. They just simply could not take the risk of their money just vanishing into the ether, and who could blame them? This only further compounded the problem on hand. This caused yet another banking landslide that promised the advent of another Great Depression. Now, with so many people invested, think not as an investor but as a regulator; can you honestly let an ailing institution just go belly up without so much as a second thought?
Indeed, in the short term that is not an option. However, that is exactly what regulators must now work towards. The situation on hand previously was a catch 22 situation, and by boosting a banks safety buffers, there is less of a dilemma on hand and the taxpayer won’t be left holding the baby if things go from bad to worse. The banking lobbyists have resisted this move for obvious reasons, for why should they support themselves when they have the taxpayers to bleed dry? But the regulatory powers that be have ably demonstrated that higher capital levels might hurt the economy a bit right now, but it is like taking an injection; it hurts a bit to begin with, but it’s all for the betterment of the individual in question eventually.
The framed rules pertaining to this will be out in November and will necessitate banks to carry capital of at least 10% of risk-adjusted assets, and this is a figure that should be enough to bear the kind of losses most banks had to face up to in the light of the financial meltdown of yore. But some banks lost a heck of a lot more money than most, and some lost twice or thrice the amount than other banks and when that happens, no buffer will be enough. And what’s more, these banks if allowed to die will take down large parts of the banking system with them in a financial domino effect since there are such strong linkages within the banking community. The need of the hour is to find a way to pass on losses to creditors without encumbering anyone else with losses as much as is possible.
There is a resolution that has been created that will see a central body take over failing or failed banks and pass on losses to unsecured creditors, but that is just the beginning. There has to be more where that came from; the largest of banks have debt totaling hundreds of billions of dollars of debt and any party to that debt will run as far as they can from banks being taken over by these authorities. Perhaps then it makes sense to underwrite the unsecured debt as opposed to destabilizing it and rattling a few cages.
Another alternative is to give these regulators sweeping powers but over a limited part of a banks balance sheet. That little tract of paper will be their kingdom for them to do as they please. This will help put corrective measures in place and also contain any panic from spreading. The new Basel norms are an example of this; it allows debt at the bottom of the pyramid (oddly called tier 2 capital) and give supervisors the power to write it off entirely or convert it into equity as seen fit. That is a decent and practical idea since it will not drive the system towards defaulting and will mean that instead banks will restructure their debt structure instead of reinventing the wheel.
But to do this, banks will have to build up the debt they hold, maybe even double it. The last worry then is to ensure that banks don’t buy each other securities, meaning everything ends up in one person’s hands! Think of AIG needing to be bailed out and you might understand why that is a worry. None of this has a surety of working, but the one thing known for sure is that when the next crisis comes around, the crazy panicking and pleas for stabilizing the system will be seen again. So steps need to be taken to impose these losses in a controlled manner as opposed to a choice between sending these banks out to sink or swim.