Bank of England chief: Basel III incomplete answer

AP News
Posted: Oct 25, 2010 5:15 PM
Bank of England chief: Basel III incomplete answer

International agreements requiring banks to hold more capital and a tax on bank balance sheets proposed by the British government are not enough to significantly reduce the risk embodied in giant banks, Bank of England Governor Mervyn King said Monday.

Speaking to the Buttonwood Gathering in New York, King said that banks deemed "too big to fail" enjoy implicit government support which in turn gives banks incentives to take on greater risk.

"The balance sheets of too many banks were an accident waiting to happen, with levels of leverage on a scale that could not resist even the slightest tremor to confidence about the uncertain value of bank assets," King said.

"For all the clever innovation in the financial system, its Achilles heel was, and remains, simply the extraordinary _ indeed absurd _ levels of leverage represented by a heavy reliance on short-term debt."

While welcoming the higher capital ratios for banks prescribed in the Basel III agreement, King said that is insufficient to prevent another crisis.

"Only very much higher levels of capital levels that would be seen by the industry as wildly excessive most of the time would prevent such a crisis," King said, adding that risks are often possible to assess.

"If only banks were playing in a casino then we probably could calculate appropriate risk weights. Unfortunately, the world is more complicated," King said.

The bank levy proposed by the British government, intended to generate 2.5 billion pounds ($3.9 billion) in tax revenue per year, goes nowhere near covering potential losses in a future crisis.

King noted that three British banks _ Barclays, HSBC and RBS _ each have assets greater than Britain's annual GDP of about 1.39 trillion pounds.

The push by King and some other world financial leaders to prohibit banks from growing too large in the wake of the Lehmann Bros. collapse has been met with resistance by the banking sector.

At a conference in London earlier Monday, Barclays PLC President and CEO-elect Robert E. Diamond argued that there was no empirical evidence that "big is bad _ in fact quite the opposite."

Noting that 140 small retail banks in the U.S. collapsed last year, Diamond said that banks dependent on a single market or product can be at greater risk, as Britain saw with the collapse of national mortgage lender Northern Rock.

"By contrast, the global universal banking model, which integrates retail, commercial and investment banking is well diversified by business and geography ... by clients and by products and it should carry less risk by virtue of that diversification if it is well run," Diamond said.

King said the solution may involve even higher capital requirements, or divorcing high-risk activity from ordinary banking.

"The broad answer to the problem is likely to be remarkably simple. Banks should be financed much more heavily by equity rather than short-term debt. Much, much more equity; much, much less short-term debt," King said.

"Risky investments cannot be financed in any other way. What we cannot countenance is a continuation of the system in which bank executives trade and take risks on their own account, and yet those who finance them are protected from loss by the implicit taxpayer guarantees. The difficulty is in finding the right practical way to achieve that."

The Buttonwood Gathering, sponsored by The Economist magazine, is named for the tree where 18th-century traders met on Wall Street.