"Bankers behave like risk takers or like speculators, if one prefers to use the terminology of the economist Tobin". This is somewhat the starting hypothesis from which the member of the Board of Directors of CEPS (Centre for European Policy Studies) and director general of Assonime, Stefano Micossi, elaborated his analysis to improve the Basel III proposals and which presented yesterday to the European Commission.
The value of capital of banks (K) plays a fundamental role in ensuring stability in the economic system: it has been demonstrated that high levels of aggregate leverage expose the economy, both financial and real, to high systemic instability. Therefore, the control of K must be placed at the center of the discussion.
The new limits imposed by Basel III are not high enough and further major improvements are needed. The International Monetary Fund and the Bank of England have shown that risk-weighted capital ratios are not capable distinguish between solvent and insolvent banks (see graph in the picture). So Micossi first suggests to increase the Tier 1 backup (too low at 3%) and to adopt a absolute value of leverage (total assets/equity) low enough to contain systemic instability (between 10 and 15 points). “An unweighted leverage ratio based on a simple and clear definition of equity” would allow capital to fulfill its 3 main functions: to strengthen the stability of the system, to allow regulators to act quickly in case of non-implementation of the rules and to re-establish a competitive equality.
We also need to improve the architecture of the regulatory system for discourage moral hazard among bankers who, as risk takers, have no qualms about pursuing their goals. Financial regulation must ensure that all of those are “internalised” in the banks negative externalities which are a direct consequence of the assumption of certain risks by credit institutions.
Micossi also suggests adopting one Prompt corrective action (PCA) on the model of the law already in force in the United States, which punishes financial institutions that show a progressive worsening of capital ratios.
Furthermore, the banks would like to adopt a high percentage of Coco bond (even 100% of K or 10% of all assets), so as to link the derivative component to the Basel accords. Convertible contingent bonds – briefly coco bonds – are bank bonds, convertible into shares only if the Tier core 1 complies with the capital requirements established by law.
Finally Basel III should provide a deposit insurance reform and a credible procedure for resolving banking issues.
To download the complete report presented by Stefano Micossi to the European Commission click here.
Attachments: S…crap_Basel_K_rules_23 November 2011_final.ppt
