The delicate economic situation being faced by developed economies is affecting many economic agents. And banks are certainly no exception. Recent tensions and turbulences have been closely related to the financial system. Subprime mortgages, real estate bubbles and rising debt in the non-financial private sector are all significant examples. As a consequence, since 2008 the share prices of European banks have clearly fared worse than those from other sectors. Moreover, the risk premium for the banking sector is way above the levels considered to be normal, the sector’s credit default swaps have reached a peak and most institutions have seen their ratings significantly lowered by rating agencies.
This tough economic situation makes it difficult for banks to redress their balance sheets. Low growth in activity, high unemployment and the fragile pulse of consumer and business confidence are not helping credit to flow or doubtful loans to decrease. The weakness in the real estate market, the drop in corporate earnings and funding problems in wholesale markets are upping the tension on intermediation between savers and investors, the very foundation of bank operations. But it’s not just the macroeconomic context. New regulatory proposals are also adding tension and complicating the management of balance sheets.
These proposals focus on capital. It started with the reforms known as Basel III, aimed at increasing levels of capital and toughening up the definition but with a long-term schedule of implementation. However, the markets and regulators have been pressurizing to bring this schedule forward. The exercise carried out recently by the European Banking Authority has been aimed at demanding higher levels of capital depending on the deterioration of the sovereign debt on institutions’ balance sheets. Consequently, either due to credit exposure or sovereign exposure, the financial systems of most European countries are still under tension. On the other hand, national supervisors, individually and independently, have used disparate criteria for their definitions and requirements of capital, as well as different schedules to apply these new rules.
Beyond capital, there are other regulatory initiatives of all kinds, such as those related to liquidity. Changes have also been proposed in the accounting of financial assets, adjustments in the calendar of provisions and duties on financial transactions. Some countries are thinking of splitting investment banking from retail banking. At a global level, more capital is required from systemically important institutions.
In short, the tensions on the financial system are both structural and regulatory in nature. The aim is to construct institutions that are more efficient, better capitalized and with less debt and more liquidity. And this is good for the financial system as a whole, for the economy in general and for customers and citizens. All that remains is for these requirements to be the same everywhere and for them not to be excessive at such a fragile economic juncture.
