More and diligent supervision of banks is at least as vital to patrolling the behaviours that might give rise to severe losses as much as a protective buffer of increased capital, the head of financial stability at the Reserve Bank of Australia said yesterday.
Luci Ellis, in a talk to an accounting conference
said that while the Basel III bank regulatory reform package was "crucial ... it would be a mistake to think that the answer to every problem is more capital."
"I can well imagine a situation where bank management and regulators become complacent about highly capitalised banks.
"They might think their bank can't possibly burn through all that capital and fail. Just like 'that ship couldn't possibly sink'.
"If the same bank gets more capital but changes nothing else, it will be safer. There will be more shareholders' funds to absorb any losses that might occur.
"But all else is not equal. The bank with more capital might feel emboldened to try to grow faster, or to take on other risks. Or it might be being required to hold that extra capital, because it has a business model that is inherently riskier in ways the Basel risk weights don't capture properly."
Ellis said that in Australia, APRA routinely sets higher capital ratios for most institutions.
"Business models differ, and thus so do inherent risks. Because of that, I wouldn't necessarily expect a bank with higher capital to be safer than one with lower capital. It might or might not be. It depends on whether the additional capital was enough to cover these less easily measured risks.
"So we should not be surprised that banks with high reported capital ratios were not less likely to fail than banks with lower capital ratios."
Ellis also highlighted the risk that managers of banks would manage to a metric favoured by supervisors.
"If you tell people to fulfil a particular metric, they will do so. But in doing so, the metric will start to lose its relationship with the thing you really care about. For this reason, I doubt that we will ever find the single variable that would ensure financial stability if only banks could be made to meet it.
"This is why diligent supervision is, if anything, more important than how simple or complex or clever the rules might be."