Nationalisation and speculation: where will the dealers go?
There's a lot of noise about nationalisation. . . In fact there is a momentum towards further state intervention and even ownership in the current situation that is coming from outside politics and is driven by the crisis of the banking business model.
Banking adopted its high-risk business model in the 2000s because its old business model - driven by flotations, mergers and privatisations, had faltered. Strip out leverage and securitisation and banking profits in the years to 2008 look meagre. Likewise much of the off-balance sheet finance was designed to get around the : if you actually make the regulations effective - as the G20 leaders promised to do - much of the bloom goes off the finance sector. Further, if you close the loopholes in the global system - the offshore tax havens - the opportunity to speculate is massively diminished.
The paradox is, even by you stick to the present regulations, all the momentum is in a direction that makes the old banking business model impossible to revive; in fact it lies in the direction of a more permanently socialized banking sector - or at the very least a "mixed economy" with large parts of the system run by the state. One senior banking analyst told me, in December 2008, that we will
"...end up with banks that are essentially financial utilities; investment banks that are more Lazard than Lehman; and with a public lending institution of some description."
A number of conversations with senior banking, legal and hedge-fund managers have pointed in the same direction.
At the heart of the Basel II treaty is the concept of capital adequacy. It is a concept that makes even senior editors groan every time they hear I am going to talk about it on TV, but it is a concept that the future of the system revolves around.
Banks have to match the risks they take by holding a certain amount of capital (see my report on the current capital problems below). The more capital they hold, the less profitable their operations - because the rate of profit is calculated against the size of your capital. The original Basel II treaty set a hard capital ratio at 4%: the total value of the banks shares, known as equity, had to be at least 4% of the size of their loan book. This is known as a Tier I Ratio. Many banks were able to "game" the regulations by shoving loans off their balance sheet into arm's length companies, so they could hold onto less capital. Now they cannot, that 4% limit becomes important. But it's no longer 4%. In response to the crisis, national regulators have imposed higher capital ratios.
The British government imposed a 9% limit by agreement during the 13 October "second version" of the bank bailout. The French government did likewise. Nobody in the banking world knows what the new, permanent replacement for 4% will be, but if it is anything like 9% this means permanently lower profits for the banking sector.
But that's only one problem. The second problem is that banks will become more risk averse. Modern regulation relies on the banks calculating the risk side of the balance sheet in good faith, with sophisticated computer models based on data. One senior corporate lawyer told me:
"If you go back beyond ten years all you have are paper records. Helpfully, all the digital data they relied on was accumulated in the boom years. In the next 12 months we will have very accurate data about what a crisis looks like and that will have to be factored into the models. If a banker tells me there's a 99.9% chance this will never happen again, I say to them: let's see in a thousand years' time - because 99.9% certainty is like saying this will never happen again in a thousand years."
A combination of regulators shutting the stable door, and the new availability of negative data will push banks into raising so much capital that they will seem overcapitalized. Their profits will look meagre.
