RatcliffeBlog - Mitch Thinking Out Loud

Will the Investment Banks Survive?

Will the Investment Banks Survive?

The Securities Industry Association (SIA), the banking industry organization of investment banks, is complaining loudly about the new capital requirements in the New Basel Capital Accord, or "Basel II." The reason they are against the program, which would increase the amount of cash banks need to have on hand, reducing the potential for sudden fluctuations in capital reserves across regions and the globe. Here's the summary:

The Basel Committee recognises that the New Accord will require more cooperation and coordination between home country and host country supervisors, especially for complex banking groups. The New Accord will accentuate the need for cooperation because the new rules will be applied at each level of the banking group....Where a banking group has operations in at least one country other than the home country, the implementation of the New Accord may require it to obtain approval for its use of certain approaches from relevant host country supervisors on an individual or sub-consolidated basis, as well as from its home country supervisor in respect of consolidated supervision. The need for approval of more than one supervisor is not a precedent; the 1996 Market Risk Amendment entailed similar requirements. However, the New Accord could significantly extend the scope of such multiple approvals and is therefore likely to create some new implementation challenges.

Even the SIA says this will be good for commercial banks, since it will prevent localized runs on banks and monetary crises like the Asian meltdown, but its members say that having to keep more cash on hand will prevent them from doing deals with the same facility as today. In other words, it could cut into their profits, which means they'd have to raise fees for the companies and investors they represent in transactions. What is not clear, based on the Basel guidelines, is whether there won't be substantial national discretion that could create bastions of banking activity (think Cayman Islands). This means that some regions could be less friendly to transactions, which could be bad, but only at certain stages--moments of crisis or consolidation--in a company's life. What isn't being addressed is whether the increased stability offered by commercial banking capital requirements being increased will not have a greater positive impact on markets than the downside the investment banks are complaining about. Or, maybe, investment bankers ought to get used to making less money. The last couple years have certainly prepared them for this reality.

Notably and probably to the ultimate emasculation of Basel II, China and India have refused to play along. Since these are two of the fastest growing economies (and China's banks are virtually insolvent), the investment bankers don't need to worry -- or, do they? If China's banking system isn't set aright, it could make any transaction in Asia far riskier and more expensive than it would be in a more stable banking environment.