By: Dr. Mike Campbell
The old saying about the value of shutting stable doors after the horses have bolted does not seem to apply in the world of finance. The global financial crisis had a lot to do with financial institutions making speculative bets that they didn’t have the cash to cover.
When the sub-prime bubble burst, a number of financial institutions went to the wall because their debt burden was simply too large and nobody was lending money at that stage. In the dog-eat-dog world of red-in-tooth-and-claw capitalism, a good few other financial institutions should have failed too, but the powers that be determined that they were “too big to fail”; this doesn’t sit well with the creed of “market forces” which will decide all, but that is what happened. Consequently, they were bailed out with public money because the consequences of allowing them to fail might have jeopardised the entire financial system.
So central bankers and politicians have been striving to come up with a self-closing stable door which will, we hope, keep most of the horses safely in the stable the next time one gets skittish. The mechanism that they have come up with is to mandate that financial institutions hold a larger proportion of cash assets.
The requirements, to be phased in over the next three years, will require banks to increase their common equity holdings from 2% up to 7%. Once fully in force, regulators will be able to refuse banks permission to pay bonuses or dividends should their common equity holdings slip below the 7% threshold. The idea is that the banks will be forced to hold enough assets to deal with a future crisis.
The moves were welcomed by markets around the world and saw banking stocks rise by between 2 and 5.8% in global markets.