G-20 Wants To Hogtie Major Banks

The finance ministers of the G-20 nations blame most of the collapse of the credit system and a portion of the failure of the global economy on the world’s largest banks. Whether that is true or not is academic as they plan to sharply cut the leverage capacity of major financial firms.

In a statement by the organization, it set out plans to curtail risky bank activity particularly in two areas:

*Stronger regulation and oversight for systemically important firms including: rapid progress on developing tougher prudential requirements to reflect the higher costs of their failure; a requirement on systemic firms to develop firm-specific contingency plans; the establishment of crisis management groups for major cross-border firms to strengthen international cooperation on resolution; and strengthening the legal framework for crisis intervention and winding down firms

*Rapid progress in developing stronger prudential regulation by: requiring banks to hold more and better quality capital once recovery is assured; introducing countercyclical buffers; developing a leverage ratio as an element of the Basel framework; an international set of minimum quantitative standards for high quality liquidity; continuing to improve risk capture in the Basel II framework; accelerating work to develop macro-prudential tools; and exploring the possible role of contingent capital.

The barrier to these principles being put into effect is that they have to go through a political process, particularly in the US. The American banking industry, Congress, the Fed, and the Treasury have already shown that they are having trouble coming to common ground on both the nature and regulatory framework for overseeing the financial system.

The free market portion of the economic and political spectrum will argue, and probably argue persuasively, that sharply monitoring and controlling bank activity will lead to lower earnings. That may cause a number of firms that have been willing to offer capital in the financial system based on “risky” lending and securitization that have been beneficial to the economy to cut back on that activity.

Mortgage-backed instruments may have been a major reason for the financial meltdown which began last year. That does not prove that either leverage or securitiation is an evil in and of itself. The fact that credit rating agencies did not do their jobs in properly rating paper is just as serious an issue as the creating of the paper itself.

There are enough political and economic interests to keep reform from making as much progress as the Treasury would like, and that may be good. Reform, aimed in the wrong direction, could curtail activity in the financial markets which has been essential to liquidity and reasonable returns on capital.

Douglas A. McIntyre