As Europe’s economies drag themselves back out of recession, a common refrain from politicians and industrialists is that their economies are being slowed by ailing banks.
Mountains of bad debts, many not yet written off, and the resulting shortage of capital are restricting the flow of credit to the rest of the economy. The response of many European bank regulators has been to look the other way in the hope that forbearance and time will revive their banks.
In the United States, by contrast, regulators are ratcheting up the levels of capital they demand of banks. Last week, the agencies that supervise U.S. banks agreed to impose a minimum ratio of capital to assets of 5 percent on the country’s biggest banks. As a result, the big banks will have to raise about $22 billion in capital.
The new rule underscores a loss of faith by bank supervisors in the notion that banks should be allowed to vary the amount of capital on their balance sheets depending on the riskiness of their lending. Leverage is a simpler, if cruder, measure of banks’ riskiness and is meant to provide a backstop to more sophisticated measures. Yet U.S. regulators are going far beyond the minimum leverage ratio of 3 percent set by the Basel Committee, which draws up international rules for banks.
This will further widen a gulf that has emerged since the crisis between the capitalization and health of U.S. banks and those in Europe. The two banking systems are not completely comparable, largely because European banks hold large portfolios of mortgages on their balance sheets. The differences are nevertheless striking. Whereas most big U.S. banks are close to their new leverage target of 5 percent, many European banks are struggling to meet the lower Basel threshold. And this gap is likely to widen as senior American regulators press for an even higher leverage ratio.
Copyright 2013 The Economist Newspaper Limited, London. All Rights Reserved. Reprinted with permission.