Over the weekend global banking regulators came to an agreement on a proposal to hit bigger TBTF financial institutions with an extra capital surcharge. What does this mean? Will this be a panacea to stop all of the banker shenanigans? Of course not! But its a strong first step. Let me tell you why. We all know that there are many forces in play when we talk about systemic risk and economic catastrophe. There is not just one policy decision that can make every one feel warm and fuzzy inside, thinking as such is just short sighted, but this decision is very important as it sets up future policy recommendations. Basel has proposed a surcharge (extra) that will range from 1% to 3.5% the amount of capital a TBTF bank has to hold on top of their normal capital requirements. This was in line with the current expectations, this is no surprise, but what was a surprise was the quality of capital the surcharge has to be comprised of. Banks can't use contingent capital. The sliding scale is also an important factor as this will take away the incentive for these institutions to get bigger.
Again, this wont end TBTF and its not a magic bullet, its a strong first step. Capital surcharges and levels will not prevent forest fires like Smokey says. Basel needs to institute toothy leverage caps and hammer down on off balance sheet/SIVS, with the eventual idea of having all of these banks properly price their inventory to proper marks. Once this is established:
1-Leverage Caps
2-OBS/SIVS take down
3-Hard Capital Requirements
4-Proper Marks on Inventory
5-Hard and Clear liquidity rules.
We can be on our way to having a more robust banking sector. Remember this. Capitalism needs to go back to being capitalism. Failure has to be dealt with. We are not going to have a financial world that is going to be an less safe for failure. This is not happening. What we need to do is - punish stupid behavior. Failure needs to be acknowledged and yes it will come. What we can is once failure does happen its not catastrophic in nature. Markets are always pro cyclical, changing this changes the very nature of capitalism and human behavior.
Instead of incentivizing TBTF, we need to dissuade these type of actions. In short we need to make getting bigger less profitable.
The advantage of getting too big is that everyone knows that Joe Taxpayer will bail out ludicrous financial dealings all through the world, but now there is a major price to be paid in terms of these surcharges. In short a very strong first step of reigning in TBTF. Banking Institutions are like people because they are run by people. They can't be changed just like you can't change people's actions and behaviors. They need to change themselves and only within changes in themselves will there be true change everywhere else.
