“It was the best of times, it was the worst of times”. In 1999, Wall Street was booming, a result of de-regulation and financial engineering. “Golden Boys” strutted in £2000 suits, bought lavish condos and drove supercars. Ten years and two busts later, global banks had brought capitalism to its knees.
Yet for all the mistakes and greed, strong and empowered banks are key to healthy economic growth. Banks are very efficient money-creators. They can take a deposit of £100 and add another £50 to £150 to the economy through credit, the lifeblood of the economy. Their success has been the hallmark of a strong economy, ever since the Medici funded Florence’s meteoric rise in the 15th century.
After the Global Financial Crisis (GFC), when it became apparent that banks had taken a few too many liberties with their client’s deposits, which made them socially systemic, private equities took point on business financing. The pandemic subsequently forced governments to enter the fray and fund millions of smaller businesses.
Only they really can’t do it as well. A bank may fund a small business, and to do so it will require a functioning business plan, perform history checks and hold meetings with the owners. Governments will prioritise social needs over businesses. And when they do focus on the latter, it is usually through blanket measures with no meaningful way to control where the money goes. Nearly £2bn in potential fraudulent loans in the UK alone illustrate the principle.
Private equities can also fund new businesses. But their firepower is much smaller. The total value of the global private financing market is $7.3tn. The total loans of just the ten biggest US and European banks surpass that number by a trillion. Also, PEs have overwhelmingly preferred high-growth tech operations which may pay them back quicker. Done properly, banking will take into account the business person’s contributions to the local community, whereas private equity will care only about the short to medium-term rate of return.
Because banks failed to manage risk, societies handcuffed them. Basel regulations and the Volcker Rule all but shut proprietary trading down and significantly curtailed lending. If you are wondering why growth in the last decade has been lacklustre and how the tech sector has grown so disproportionally to the rest of the economy, look no further than post-GFC regulation.
We have long maintained that authorities would eventually be tempted to loosen GFC-era rules, in the name of healthy and broad-based economic growth. Some talks had been underway, but last year’s failure of Credit Suisse and US peripheral banks threw a spanner in the works.
Still, the most important issue in the global economy right now is not interest rates. Rather it is the debate taking place in the halls of Washington and Brussels. Basel III, the third set of major banking regulations, is due to be fully implemented by January 2025. It is estimated to raise capital requirements by 3% for UK and 9% for EU banks. In the US, where the regulatory requirements may be tougher, the number could be as much as 16%. Such high capital requirements would prevent banks from giving out many loans, curtailing credit.
US banks are already fighting back with an army of lawyers, lobbyists and a media blitz regarding the “Basel Endgame”. Michael Barr, the Fed’s Vice Chair of supervision admitted last week that the regulator might tone down some of the requirements.
Ultimately, there’s no free lunch, no perfect solution. Capitalist societies will have to make an unoriginal choice, one they have often made in the past: fewer capital requirements mean more risk, more growth, more busts. More capital requirements mean less risk, subdued and possibly uneven growth, but less systemic consequences.
Bank regulation is a very important social ingredient. Do we, as a society, want to enjoy luxury, at a considerable risk that it will not last, i.e. the inevitable booms and busts of capitalism? Or does the necessity for stability tramp ambition and concerns over broader-based growth? Are “golden boys” (now “tech bros”) inevitable?
More importantly, should such an imperative question only be answered in closed rooms by unelected, albeit carefully selected, specialists, or should it be the subject of an open-air debate?
