Ten years on from the global banking meltdown, UK banks are still vulnerable according to Martin Wolf in the Financial Times:
“Senior officials argue that capital requirements have increased 10-fold. Yet this is true only if one relies on the alchemy of risk-weighting. In the UK, actual leverage has merely halved, to around 25 to one. In brief, it has gone from the insane to the merely ridiculous.”
According to Wolf, the reforms that were put in place after the 2008 crash simply failed to tackle the fundamental contradiction at the heart of the modern banking system:
“Banks create money as a byproduct of their lending activities. The latter are inherently risky. That is the purpose of lending. But banks’ liabilities are mostly money. The most important purpose of money is to serve as a safe source of purchasing power in an uncertain world. Unimpeachable liquidity is money’s point. Yet bank money is least reliable when finance becomes most fragile. Banks cannot deliver what the public wants from money when the public most wants them to do so.”
This was obscured by the bankers in 2008 when they claimed to have a ‘liquidity’ problem when in reality they had an ‘insolvency’ problem – they weren’t strapped for cash, they were broke. This led governments and regulators to take a light-touch approach to capital requirements (the ratio of money held in a bank to the money it loans out) and bail-ins (making shareholders and large depositors rather than taxpayers liable for losses). According to Wolf, full-blooded reforms of this kind are unlikely to happen:
“Radical reforms are desirable. But today this is politically impossible. We have to build, instead, on the reforms introduced since the crisis.”
These include a ‘ring-fencing’ of commercial and retail banking that falls short of complete separation. But according to Wolf, the immediate need is to make banks hold far more equity than is currently the case so that the balance of risk falls on shareholders rather than taxpayers – whose money can also be protected via alternative means of creating money; including via central bank balance sheets.
For the time being, however, taxpayers and the wider economy are still on the hook for future bank losses:
“The conclusion is simple. Banks are in better shape, on many fronts, than they were a decade ago (though the questionable treatment of income and assets in banks’ accounts continues to render their financial robustness highly uncertain). But their balance sheets are still not built to survive a big storm. That was true in 2007. It is still true now.”
We can but hope that big storms do not appear on the horizon before we’ve got around to fixing the roof.