Here’s an idea: set bank rules to stimulate risk-taking. Sounds odd, does it not, given recent, sad experience and the market’s current travails. But, in a speech yesterday, that’s just what one of the world’s most important regulators – and, to date, a vigorous capital hawk – has suggested. Perhaps bank regulatory policy may finally be righting the balance between reasonable rules and sensible profit.

The startling remarks come from Andrew G. Haldane, Executive Director for U.K. financial stability at the Bank of England. The paper is dense, with a dozen or so charts that walk the reader from 1933 to the current crisis and back again. What’s new here is not so much the assessment of the causes of the crisis – been there, done that in lots of recent regulatory pronouncements and Mr. Haldane stands with them in citing leverage as a principal culprit. What is new here is the focus not just on the crisis, but also on how to get out of it. And, the suggestion is revolutionary: adjust regulatory-capital and examination standards down, not up.

A key conclusion in the Haldane paper states that, “The crisis of the past few years has highlighted the need to free the macro-prudential arm of policy. As in the 1930s, macro-prudential policy may have a role to play in shouldering the heavy burden of damaged balance sheets and diminished risk appetites.” It doesn’t sing, we know, but the point here is clear: regulators may have gone too far too fast to repair prior damage. As a result, banks are so capital-constrained and risk-fearful that they won’t lend even where risks are clearly minimal.

No loans means no recovery, as the quagmire in the U.S. makes all too clear. This has posed a profound macroeconomic dilemma for the FRB and Treasury, with each responding with traditional monetary-policy and fiscal-stimulus tools. Mr. Haldane’s radical point is that there is what he calls a “third arm” in the body politic to address the “great recession.” This goes beyond the microprudential body of capital and prudential rules to focus on broad macroprudential issues like whether rules are too lax or too tough, based on whether systemic risks or macroeconomic problems are evidencing themselves. From the macroprudential perspective, the key question Mr. Haldane then poses is whether microprudential capital standards are now set so high in tandem with the penalties for violating them that banks simply are stuck in neutral. If so, banks may repair their own balance sheets, but only at the cost of the broader economy.

We would add that this repair is always one step behind the next regulatory demand. Thus, banks could in fact be engaged in a vicious cycle: those that raise capital find it still insufficient to meet new rules – e.g., the pending systemic surcharge and capital-distribution limits. Even though they meet current rules and thus could lend again, they won’t out of fear that the bar will just go still higher. Looking over the horizon of pending proposals to the next round of capital rules means that banks with ample capital still need to stockpile it lest they fail the next call. In the U.S. any such failure would pack a particularly hard punch due to the strict new requirements under Dodd-Frank for banks that aren’t “well-capitalized” under the old Basel I requirements. And, so banks go right back to the bunker even after a round or two of capital hikes.

What’s the solution here? Mr. Haldane doesn’t say, other than to drop some pregnant hints about the counter-cyclical capital charge in Basel III. With a few of his famous charts, he shows that the charge would have helped to offset the boom and, now, is contributing to the bust. Will this take this part of Basel III back to the drawing board? We hope so, along with several other proposals – most notably the capital surcharge – that are not just ill-thought out, but also grievously ill-timed.

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