This week’s Fall Through the Cracks Friday is an article by former FDIC Chair, and keynote for the upcoming PLUS D&O Symposium, Sheila Bair. In the full article from Fortune magazine, Ms. Bair argues that lax lending restrictions in Europe are only starting to be rectified.
From the article:
The U.S., which has tighter rules governing how FDIC-insured banks determine the riskiness of assets, requires well-capitalized banks to hold capital equal to at least 5% of total assets, regardless of how risky they think the assets are. So for any asset, be it cash, U.S. Treasury securities, or supposedly safe mortgages, banks must hold at least 5% capital against it. European banks do not have this kind of “leverage ratio,” and Basel II has allowed them to treat sovereign debt as having zero risk. That is one of the main reasons they have loaded up on nearly $3 trillion of it.
Last year the Basel Committee on Banking Supervision finally approved a still-too-low 3% international leverage ratio. Even at that permissive level, the committee’s own research suggests that more than 40% of the world’s largest banks would have to raise capital. At the same time, the European Banking Authority (EBA) is raising European banks’ common equity capital requirement to 9%, a huge jump from the Basel II standard of 2% and roughly equivalent to the new Basel III standards. But even at 9%, a large number of European banks will continue to operate at extreme levels of leverage because of their rosy views of risk.