EUROPE - Applying Solvency II flexible funding rules to banks would have substantially reduced the need for recent government monetary support to the sector, academics from French business school EDHEC have claimed.
A report produced by Noël Amenc, professor of finance and director of the EDHEC Risk and Asset Management Research Centre, and Samuel Sender, applied research manager at the same division, suggests most cash injections from European public funds into struggling banks would have been "unnecessary" had a few minor changes been made to funding rules ahead of the recent crisis.
More specifically, the authors note while regulators and international institutions have suggested capital requirements on banks will need to increase, the move would be counter-intuitive and improved funding level stability would be achieved were the European Commission to apply capital requirements managing those applied to insurance companies.
"The financial system can be stabilised only if capital adequacy ratios are allowed to fluctuate," said Amenc and Sender.
They recognise several European regulation-related bodies have argued there is a need for more capital buffers to improve the capital strength of banks while the Swiss regulator (SFBC) said last year "the new capital adequacy target ratio for UBS and Credit Suisse will be in a range of 50% and 100% above the international minimum requirements".
Yet the authors note it was not capital requirements which created the crisis, so they instead advocate "a pragmatic approach inspired by the Solvency II framework for insurance companies" would be more appropriate, which saw a floor or minimum capital requirement applied "beneath which bankruptcy is legally questionable" along with a flexible target equivalent to the average capital requirements over the cycle, leaving banks to manage a buffer between the two which would limits banks' need to seek capital elsewhere.
"This distinction between the target and the floor would make it impossible to limit the banking sector's contribution to the formation of speculative bubbles," said the EDHEC report, and would "limit injections of public funds into banks".
Figures presented by EDHEC suggest the global commitments to banks since the crisis began last year has now reached €4.423trn, though most of this was to refinancing.
At the same time, EDHEC has claimed the need for financing could have been avoided ahead of the crisis had the Tier 1 capital ratios been set at a slightly lower level.
Authorising Tier 1 capital to be as low 3%, instead of 4% as currently required, "would have obviated most of the need to raise capital if the decision to authorise this flexibility had been made when the bailout plans were drawn up and accounting standards were amended."
Similarly, Amenc and Sender argue clarifications to IASB rules and a change to accounting classifications is, "with hindsight", unlikely to restore confidence in banks".
It is very surprising that governments have done very little to remedy the flaws in rules for bank capital, although they were quick to modify accounting standards, the role of which is largely to ensure that comparisons over periods of time are possible," suggested the report's authors.
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