Should the Public Subsidize Banks?

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Capital Requirements for Banks Hotly Debated

Ben Chu writes:  A senior official at the Bank of England has been accused of misleading the public about the safety of UK banks.

Alex Brazier, the Bank’s executive director of financial stability, rejected calls for private banks to be compelled to have considerably larger capital buffers to protect the financial system from another crisis.

He cited Bank of England estimates that a 1 percentage point increase in capital requirements across the board could knock around 0.6 per cent off GDP. “The costs will be borne by real borrowers in higher costs of funds and real savers in lower returns,” he warned. But Mr Brazier’s remarks drew a strong rebuttal from Professor Anat Admati of Stanford University, a widely acknowledged expert on the banking sector.

“I am alarmed by Mr Brazier’s speech because it confirms that important policy regarding financial stability is based on flawed claims and flawed research,” she said.

Ms Admati rejected the Bank’s estimate of the wider economic cost of banks using more capital and said one reason banks might find it more expensive to fund their balance sheets with more equity and less debt was because their de facto public subsidies from the taxpayer, such as being “too big to fail” and the tax deductability of debt, would have been eroded.

“It is disturbing that the Bank’s head of financial stability seems to be more concerned with supporting the banks by making flawed assertions that contradict fundamental principles of corporate funding,” she said.

The row comes at a time when the Bank is under serious pressure to reconsider its capital rules. The position of Mr Brazier, who was appointed to his current position last year, seems to be in line with those of the Bank’s Governor, Mark Carney. Mr Carney has repeatedly sought to assure bankers that there will be no additional capital requirements made on them in the coming years. Referring to the international “Basel” agreements on capital standards sealed in 2011, Mr Carney insisted in Shanghai last month: “There will be no Basel IV”.

In his new book The Age of Alchemy, Lord King takes a tough line on capital, saying it would be “a good start” for banks to have a minimum ratio of equity to total assets of 10 per cent. The Bank is currently planning to require them to have equity worth only between 3 and 4 per cent of total assets. For her part, Ms Admati says banks should have 20 per cent buffers.

“Their hatred of equity only confirms that the subsidies are substantial to their business model – but the subsidies come from the public,” said Ms Admati.