Making banks more stable and resilient is one of the key questions in the current European crises. It seems, that regulators and policy makers have reached a consensus, that banks generally should prop up their capital base to have bigger buffers against losses at their disposal. While this is generally a comprehensive objective, I do not aggree, that it is one of the most pressing problems in this phase. So I would like to pose two more or less provocative questions:
1. Is the capital base of European banks really too low?
Just remember: before the crises the minimum regulatory capital stood at 4% Core Tier 1 (CT1). Most banks had an equity base of around 6%. Although this was low, the most prominent failures were caused by a shortage of liquidity, not capital. This was the case at Northern Rock in the UK, IKB in Germany and Lehman Brothers in the US. Same picture two weeks ago at franco-belgian Dexia. Nevertheless capital remained a key focus of the various banking reforms and that was of course also correct. The effect is, that today the average bank has a CT1 of 9%, many arrive even in the double digit area. But nobody seems to take notice of that.
So Ladies and gentlemen: How much capital would be appropriate? This not a scientific question, but it depends on two factors: the political and the market sentiment. Many politicians would like to make banks so robust, that they cannot fail anymore. In such a scenario banking cannot be anymore a profitable business and should therefore - as a consequence - be socialized. And the markets? If they really see a benefit of higher CT1 ratios can be doubted. If that would be the case the Swiss banks UBS and CS (with CT1 over 15%) would structurally over perform the likes of Deutsche or Barclays, which is not the case.
2. So - if its not capital - what are the real problems surrounding banks?
The flawed stress tests have shown, what's the key question: it is the reliability of sovereign debt. All banks have more or less large amounts of sovereign debt on their balance sheets. Italian banks have Italian treasuries, French banks bonds of the French government. Most of them have also some sort of troubled peripheral debt, Greek or Portuguese in their books. How much are these holdings worth? It makes a huge huge difference, if these bonds are considered risk free or have to be discounted by - say 50%. No capital base, even the highest, could not withstand in that case. But: on what depends the value of sovereign debt. This is exclusively a political question. If Europe guarantees seriously with all it's firepower for example Italian and Spanish debt, it suddenly becomes risk-free. If not, it should be marked to market, Billions of losses would depress the banks threatening the recovery. I have the feeling, that the governments - overall the German - prefer to talk about banks capital ratios while they should absolutely focus on the question of sovereign debt.