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Bank bust prevention

Posted: Thursday, September 16, 2010

The following editorial first appeared in the Chicago Tribune:

When it comes to the financial crisis of 2008, which resulted in the implosion of some of the world's premier lending institutions and devastated the economy, there are plenty of disagreements about why it happened and how it was addressed. But everyone concurs on one thing: It should never be allowed to happen again.

That's the reason for a new plan by the world's chief banking regulators, reached last weekend in Basel, Switzerland. They agreed that business can't go on the way it did before, when lax lending standards and weak regulatory controls spurred banks to take excessive risks. Those risks led to disaster when the housing market went bust, inflicting huge losses on lenders. In the end, governments had to come to the rescue.

The chief remedy in the Basel accord is higher capital requirements. Before the crisis, banks were generally required by international rules to hold capital equal to 2 percent of their assets, with big U.S. banks mandated to hold 4 percent. Under the new rules, they will have to boost that amount to at least 7 percent. Those that fail to comply will face restrictions on payment of dividends and compensation.

The goal is to limit the exposure of banks, while making them better able to weather unforeseen misfortunes without going bust.

It's a bit like requiring homebuyers to put up 20 percent of the purchase price, instead of 5 percent, to get a mortgage. The banks will be sounder, and taxpayers will be less likely to get left holding the bag.

But two chief criticisms have been heard. The first is that the rules will make banks less profitable and less willing to lend. That's true, but the greater safety is well worth the price.

Given the reckless behavior that spawned the crisis, less lending - and more prudent lending - is not a bad thing. It's a good thing. Banks that can't make money without taking excessive risks are banks we can do without.

The second comes from the other side of the debate, arguing that the rules are being put off too long. There is some truth here: Banks would not have to start boosting their capital until 2013, and all the obligations would take eight years to phase in. That may explain why bank stocks rose in response to the new rules, which were more lenient than many experts had expected.

Is that schedule too deliberate? Maybe so, but there are obvious risks to moving too fast. Early in a weak recovery is not the ideal time to make sudden, heavy demands on financial institutions. Besides, a lot of banks have already upped their capital on their own, going beyond the minimum requirements.

The agreement may fall a bit short of perfection. But for anyone who dearly hopes to avoid ever living through another collapse like the one that occurred in 2008 - which is just about everyone - it is unquestionably a big step in the right direction.



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