Are banks safe in our time?
September 28th, 2010
The Basel Agreement on banks has been hailed by its supporters as a guarantee we will not have another Credit Crunch. Once the new proposals have been worked out and implemented, banks they say will have enough capital to get them through difficult times, even times as difficult as 2008.
Nothing is a simple as that. The full measures will only be implemented by 2018, so there are some years ahead when some banks may not meet the new Basel capital requirements. The Basel plan requires banks to hold more cash and capital, and favours holding cash in the form of government bonds. This may not be such a good idea in weak and over borrowed countries, where the government debt itself is being questioned. The Credit Crunch may have begun as a crisis of confidence in private sector loans advanced by banks, against a background of the banks having insufficient capital to pay all the losses on those loans. It is moving on, to encompass worries about some governments’ financial positions. Exposing banks more to this may not be a good idea.
More importantly, Basel assumes that the crisis was the result of bad banking judgements. It was also the result of some bad central banking judgements. Monetary authorities and bank regulators allowed banks to overextend their balance sheets in the apparently good times, then lurched to restricting the flow of money and credit to those banks in the bad times which made their positions difficult or impossible. Basel offers us no solution to bad central banking, which could lie behind a future crisis as surely as it helped engineer the last one.
Investors need to think about the future, not the past. Lightning rarely strikes twice in the same place, but no-one manages to abolish lightning altogether. The worries today are not the same as the worries in 2007-8. Today more of the spotlight is on the solvency and liquidity of governments as they wrestle with deficits. If they cut too much in a way which lowers output and undermines confidence, they can end up in a worse position, with lower tax receipts to cut the borrowing. If they do not cut enough from their spending, they may lose market confidence, forcing up their interest rates and the costs of all that debt.
Investors should look beneath the market spin to the underlying realities. The USA is borrowing too much, and may be about to elect a Congress which takes the deficit more seriously. The Euro area is still split between the stronger and weaker states. The problems of the Irish banking sector and the Greek deficit have not gone away and could come back to disrupt the zone. China and India are still working on reducing their inflation rates by monetary squeezes.
The Big picture still appears to be one of a world muddling through with modest growth. The better longer term opportunities lie in the emerging economies, as the huge deficits and trade imbalances afflicting some western economies are proving obstinate to shift. Basel IIII has not saved the world. It has confirmed the divisions between those who think we need a more austere era of prudence, and those who want to keep the monetary bubbles going to avoid too much damage to output and incomes. The compromise is to make us more prudent in due course, but to allow governments to carry on borrowing.
As published in Investment Week
