EU Proposes Kicking Banks When They Are Down?

Bloomberg did not report this story in enough detail to be certain, but as it reads, the EU will be imposing rules on member banks that will require them to hold more capital now.

That’s a good thing, right? Banks need more capital, after all.

Not exactly, When banks are imperiled, the first priority is to try to get them back to the level of capital considered necessary before they went into crisis, but offer some latitude if it looks like they are good citizens (or have decided to clean up their act if they misbehaved) and have a realistic chance of pulling through. As a matter of form, regulators use various methods to cut them some slack. The term of art is regulatory forebearance.

Some of the approaches are debatable. For instance, the move in the US to let banks fudge the value of infrequently traded assets looks to be a bad idea. Counterparties already don’t trust each other, so why let financial firm get more creative with their accounting? This initiative could well be counterproductive.

Now a newly-popular theory is that capital requirements should be pro-cyclical. Just as banks get a break in bad times, they should be asked to sock away even more capital in really robust times. That would help prevent asset bubbles too. While it sounds hard to implement, there are some ideas that have been worked out in some detail that sound viable.

However, asking banks in a credit crunch to increase their capital (not to fill shortfalls, but by imposing higher standards) is draconian and likely to worsen the credit crunch. Yet that is what the EU appears to be preparing to do by imposing higher capital requirements on asset backed securities.

Mind you, we are not objecting to the concept, but how it is implemented, Putting it in place shortly runs counter to normal regulatory practice, which is why we suspect Bloomberg may have omitted some key details.

For instance, the EU may apply the new, tougher standards to newly acquired ABS, and have a phased-in implementation for existing positions. Or they may calculate the ratios using the new metrics, but not base enforcement on those ratios for a transition period. But as it reads the EU measure is surprising.

But this may be exactly what it appears to be. As John Dizard noted in the Financial Times:

So the central bankers, and, by extension, taxpayers, will be underwriting the present system for some time.

Not that they are happy about it, and their unhappiness will be expressed through harsher capital ratios and the forcing of common equity issuance on ever-worse terms. You can expect more contradictory public policies, such as calls for restimulation of the economy accompanied by regulatory insistence on putting more securitisations on the balance sheet, reducing lending capacity.

From Bloomberg:

European Union banks will have to hold more capital for asset-backed bonds as part of a regulatory overhaul proposed today in response to the worst financial crisis since the Great Depression.

Charlie McCreevy, EU financial-services commissioner, advanced measures to tighten the oversight of lenders and curb practices such as selling off questionable loans to investors that led to a global credit crunch and record bank losses….

McCreevy’s proposal seeks higher capital standards for the securities built out of loans or other assets, referred to as structured finance, at the heart of the market turmoil. Lenders also would get stricter limits on the size of any individual risk they take on, even if from another bank.

The measure also seeks to tighten cooperation among regulators, with each multinational bank overseen by a college of the authorities from every country where it does business…..

“Capital requirement reductions for risk mitigation in the past haven’t always reflected reality and regulators are to some extent catching up with that, said Derek Chambers, an analyst at Standard & Poor’s Equity Research Ltd. in London. “Making the capital requirements responsive to risk is right. Not allowing artificial devices to arbitrarily reduce regulatory capital is right. But I’m not sure that altering one little piece of the jigsaw is going to solve everything.’

Print Friendly, PDF & Email


  1. Anonymous

    “Now a newly-popular theory is that capital requirements should be pro-cyclical.”

    Shouldn’t that be counter-cyclical?

  2. Ginger Yellow

    The full text of the proposal should be up here shortly. I’ll have more to say when it is. For now, it looks like they’ve adopted roughly the first draft rather than the second one they put out in July, and added a due diligence requirement for investor banks. The latter’s certainly a good idea, but I’ll have to see the detailed proposal to comment on the former.

  3. Anonymous

    First thought that hit me was it’s a push to get this stuff off balance sheets and over to the soon to be US bailout fund.

  4. baychev

    good! credit growth should moderate to no more than 2x GDP growth, to both stimulate people to work and not exessively devalue money.

  5. François

    I definitely prefer the way Eurozone handles problems.

    1)cash is widely available at our reserve bank. At a cost. Yes, money has a cost…

    2)currently banks do not trust each others. They can lend to BCE. At a fair value (4.x%).

    3)a number of banks will fail mostly because of their exposure to anglo-saxon debtors. Countries will decide how many they want to rescue at their tax expense. But they will have significant capital stake in every case.

    Of course Trichet will have to organize some sort of E-C-wide stuff for our Florida(s) in the so called Club Med (copyright Ambrose E-P) and possibly Ireland.

    Why is the US is only able to provide incestuous subsidies when a plain nationalization scheme is required?

    This is now behond me.

  6. River

    ‘Why is the US only able to provide incestuous subsidies when a plain nationalization scheme required?’

    One possible reason is to hide any fraud that might have been committed. As long as the banks do not have to open their books to all and sundry, a cover up of fraud is possible. Once the books reach the light, fraud will become aparent.

  7. Anonymous

    Guys: I found the comments below on dealbreaker. The blog below indeed did not miss a single call since I started following it. It is legit. pay attention to stuff your pockets!

    The blog (which nailed every single market timing call since its start back in June) has just issued a call to go long Nasdaq-100 with NDX in the 1550 area.

    Get in pyramid formation folks. After test of bottom this babe is heading higher.

    Fireworks tomorrow! Details of call and entering/scaling in link below.

  8. Ginger Yellow

    OK, some preliminary thoughts. The retained interest isn’t actually the most novel thing about this. For a start, they’ve cut it from 10% in the second draft (and capital against 15% in the first) to just 5%, which is only a bit more than was typically retained anyway. Furthermore, a) they don’t appear to be talking about the bottom 5% of the capital structure, but 5% of each tranche sold, and b) it only applies to “exposures incurred by the credit institution after 1 January 2011”.

    The most interesting things about this from my perspective are that:

    a)It imposes for the first time a due diligence and surveillance requirement for securitisation, something I’ve argued for for a long time. The requirements are quite detailed and intensive, although they are certainly reasonable from a risk management perspective. They will almost certainly cause some investor banks to exit the market, although these are likely ones who were burned in the crisis and in the process of exiting anyway. In the long run it should greatly improve the quality of the investor base and improve the quality/risk sensiviity of ABS pricing.

    b) It also mandates disclosure of asset performance and retained interest by originator/sponsor banks in order to obtain capital relief for the securitised portion. This is huge and should be of great benefit to the buy side.

    c) It also requires originators to underwrite securitised loans with the same criteria as for balance sheet lending. While this was effectively the case already (at least in the UK, where the FSA forbids differential treatment of securtised and balance sheet assets), it may make enforcement easier and may have some impact on pricing – in the past loans intended for securitisation would often be priced with a lower coupon than those intended to be held on balance sheet. That may now be illegal, although the wording is somewhat ambiguous.

  9. bg

    capital requirements and mark-to-market are two sides of the same coin, right? We want consistent rules in good times and bad, so that we don’t have to tighten the rules at a time when the rules are already tight around the neck.

  10. kona

    Did Ya’all see this?

    “The House is limiting e-mails from the public to prevent its websites from crashing due to the enormous amount of mail being submitted on the financial bailout bill. As a result, some constituents may get a ‘try back at a later time’ response if they use the House website to e-mail their lawmakers about the bill defeated in the House on Monday in a 205-228 vote.”

  11. Anonymous

    yes, and the phone number to the congress is jammed as well…also, you can’t bulk email anymore, need to go to each indiv. congresspersons site…the people have spoken and the reps don’t care…

  12. Anonymous

    Be trying for two days to contact Joe Pitt PA congressman to vote no and cannot make contact. Had no trouble before the congress voted but no it is not possible.

    Nice move.

  13. schekker

    Regarding the timing, I would say it is excellent. The right time to introduce new legislation is when the banks are down and everyone acknowledges these rules are necessary. It will take at least a year before anything comes actually into law, probably longer, and if the banks haven’t recovered by then it is soon enough to start thinking about some temporary relief.

  14. Anonymous

    Let us remember how Enron ended; when the banks that lent them money started to be insistent on getting it back, Enron went bankrupt as it didn’t have it.

    Now the same story is happening to the US as a whole, and the current administration is desperately trying to cover up the massive fraud that took place.

Comments are closed.