British Banks’ Comedy of Terrors

WASHINGTON, DC – The devil is always in the details. And the greatest devils of our economic age lurk in the details of how officials regard the capital – the equity funding – of our largest banks. Government officials have identified far too closely with the distorted, self-interested worldview of global banking executives. The result is great peril for the rest of us.

In this surreal world, the United Kingdom takes on disproportionate influence, because London is still a top financial center – and because the biggest banks in the United States and Europe have proved very effective at playing off American and British regulators against one another. Opinion leaders around the world look to the British for a clever and nuanced approach to financial-sector policy. Unfortunately, they currently look in vain.

To understand the precise problem, you must dip into the latest details of the Prudential Regulatory Authority’s “capital shortfall exercise” with eight major UK banks. I won’t pretend that the PRA’s work is easy reading for a layperson; but anyone who spends a little time with the documents will first laugh and then cry.

With great fanfare (and generally favorable press coverage), the PRA announced that some banks do not have enough loss-absorbing capital – relative to target levels of equity that are ludicrously low. The Bank of England’s Financial Policy Committee (FPC) said that the target should be 7% of risk-weighted assets under Basel III definitions. And, in the PRA’s presentation, this amounts to a leverage ratio of around 3% for most of these banks (again using Basel III definitions), though a couple of banks will need an additional adjustment to reach that level.