Contradictions in new bank rules create fresh risks

ECONOMIC issues will dominate political discussions about the votes taking place across the EU in the coming month. As well as our own local elections, there are local elections in Germany and Italy, presidential elections in France and Hungary, a general election in Greece and a referendum in Ireland on the EU’s new fiscal treaty. Economic recovery is stalling on the back of Eurozone turmoil, as the sovereign debt crisis bites after many years of poor decisions and overspending by governments.

Not surprisingly, banking regulators and standard setters are promoting major changes supported by governments of all political persuasions. Capital is being increased both in ratios and in absolute terms, significant liquidity requirements are being introduced, deleveraging is taking place and there are major enhancements to risk controls. The industry agrees with the broad thrust of the proposals and is positively engaged in getting the intentions of the policy makers into the right operational place.

But there are contradictions. For example, policy makers – and indeed the public – want both fiscal austerity and investment. They want policies for stability as well as policies for growth. They want more competition in banking and financial services while the stability measures increase the barriers to entry. And they want fewer interdependencies, but without losing the economies of scale.

Dealing with these competing requirements is difficult for the industry and it is difficult politically too. These last two decades have seen elections won by those parties who promised more spending, who targeted more groups with more promises and who handed out more benefits. This approach is neither fiscally nor politically responsible, nor is it confined only to a few countries. The norm has been for countries to spend more and more, financed by borrowing.

Now we face a world in which politics and finance have become dangerously intertwined and, as a consequence of new regulatory requirements, the banking system is required to take on ever-greater volumes of government debt. This has brought two obvious results. The first is that it may make it easier for some countries to sell their debt than would otherwise be the case. But the second is that it is tying the banking industry even closer to government decisions. If sovereign debt is to be the safe and liquid investment that regulators have designated it to be, then governments have to keep to tough fiscal policies. However, tough fiscal policies are not necessarily an acceptable choice for governments, or the citizens who elected them.

The result is this: the more banks are exposed to the sovereign debt of politically volatile countries, the greater the fiscal risk taken on by the banking system. And the more important therefore it becomes to address the causes of the economic problems by putting in place the right monetary and fiscal policies, rather than just addressing the symptoms by recapitalising some banks due to the downgrading of a country or countries’ sovereign debt.

Angela Knight CBE is the chief executive of the British Bankers Association.