Tuesday, September 08, 2009

Aligning bank's size to the economy

After you've

  • set required capital ratios
  • asked banks to holds capital against every balance sheet
  • hold the right type of capital- unencumbered permanent share capital
  • request a "will"
  • request banks' single counterparty exposure be limited to a multiple of capital

You still won't have tackled the largest elephant in the room so to speak. That is banks that are so large that you don't want them to fail because the cost of rescuing is too prohibitive. Socially, financially, economically locally and maybe even globally, these banks become a threat with economies of scale outweighed by externalities.

The answer is a removal of a one-size fits-all and move to a more dynamic capital adequacy system. Regulators and governments set minimum capital requirement with reference to the growth in the banking industry's lending as a proxy for the economy.

But then for banks that are growing, you require that they adjust their capital ratios in line with year on year the growth of their balance sheets. Similarly, those that particularly large should have higher capital ratios.

The methodology is intuitive and can be applied even to simple regulatory systems like Kenya's. i.e. while each bank must have a Ksh1bn plus, those that are growing fast or the top 10 should hold higher capital Ksh2bn and the top five Ksh3bn or higher capital ratios.


Samora said...

One thing that banks can do in this case is that the regulators can split their functions and set up the boring deposit taking and lending division as well as setting up the exotic side to banks. Treating them as seperate entities in this way will ensure that nobody is too large to fail, if the exotic risk-taking side messes up then you can just let them fail. I like your blog and I have one of my own at www.futurecapitalkenya.blogspot.comfeel free to visit and share on the articles posted

MainaT said...

Samora, thanks for visiting. I think your idea was actually considered earlier in the yr, but cast aside bcos its now notable that most banks do operate well even in the dual role. Its just that previously they didn't have to hold capital against the trading book. Going fwd, this is something they'll have to do.

MainaT said...
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