Will Regulators’ Fixation on Capital Produce Blind Spots?
By Barbara A. Rehm
Policymakers are obsessed with capital, and it’s easy to understand why. It is central to confidence in the banking system. It is quantifiable. It’s tangible. Those are all good things, and everyone agrees a solid banking system is founded on a sound capital base. But the focus on capital may be creating a false sense of security, and it may be overshadowing other, equally important issues that are central to preventing the next crisis, like how well banks are managed and how well supervisors do their jobs. To be sure, Basel III is more sophisticated and will be augmented by tools provided by the Dodd-Frank reform law, including mandated stress-testing. But it is capital that is getting the bulk of regulators’ attention, and ironically the last crisis was not a caused by a shortage of capital but rather by a lack of liquidity. U.S. regulators are working with counterparts around the world on new standards to ensure a company has the funding it needs when problems arise. But those rules are not done yet and it is still unclear if they will work. And while regulators are tackling both capital and liquidity under the Basel Committee on Banking Supervision, there is a big gap in how supervisors plan to deal with troubled banks that operate across borders. How “too big to fail” institutions are resolved is a key issue and one where the U.S. is going it alone with its plan to end bailouts and rely on bridge banks to unwind large, complex banks. As Karen Shaw Petrou of Federal Financial Analytics put it to me: “The rest of the world is not using the ‘shoot ’em but let them die slowly’ approach. The rest of world is enshrining ‘too big to fail’ and making companies and their investors pay for it” through special taxes and bail-in debt.