European policy-makers weigh stopping bank capital increases
European policy-makers are weighing whether to stop pumping up bank capital and instead let some air out of the system. While global regulators have spent years reinforcing capital standards since the 2008 financial crisis, recent economic stability has sparked debate over whether current requirements have become unnecessarily restrictive.
Resilience Through Recent Crises Sets the Stage
Most banks have weathered a string of recent crises without severe damage, providing evidence that current capital levels are adequate. Regulators have praised banks for being part of the solution to the economic turmoil resulting from the Covid-19 pandemic. When the Ukraine invasion triggered energy market swings, only Russian banks suffered major wounds.
Credit Suisse and a handful of US regional lenders stand out as the notable exceptions to this stability. Management missteps and a complete loss of depositor confidence doomed Credit Suisse in 2023 despite its strong capital figures. Meanwhile, the collapse of Silicon Valley Bank exposed a different vulnerability entirely.
Anatomy of the US Regional Banking Collapses
US regulators noted that capital wasn’t the primary issue when Silicon Valley Bank failed. Poor interest rate risk management and a liquidity profile that prevented the bank from monetizing assets quickly enough to pay fleeing depositors drove the insolvency. SVB's capital levels failed to reflect underlying risks hiding inside its bond portfolio.
The Paradox of Trimming Capital Standards
To address this, US regulators removed a regulatory filter that previously ignored unrealized bond losses from capital calculations. Yet that specific regulatory fix simultaneously handed a 3% to 8% capital reduction to regional banks. Critics point out that trimming capital standards while panic spreads seems counterintuitive, especially when geopolitical instability and volatile sovereign bond markets continue to rattle investors globally.
Weighing Growth Against Systemic Vulnerabilities
Global financial stability remains fragile as sovereign debt doubts shake markets like France. Populist political decisions and massive debt loads carried by artificial intelligence companies add further layers of corporate risk. Some regulators argue these looming dangers make this the worst possible moment to relax capital rules.
Balancing these competing pressures requires careful calculation from central banks. Freeing up capital could theoretically stimulate economic growth and boost tax revenues to ease heavy government debt burdens. However, policy-makers must decide if that potential growth outweighs the risk of diluting the buffers meant to protect the broader financial system.