A SIMPLE way to judge the solidity of a bank is to compare the amount of money it can afford to lose without keeling over to the size and riskiness of its business. After the financial crisis, regulators sensibly worked to boost the first figure: banks now fund their lending less with money they borrow themselves, often from depositors, and more with capital belonging to their shareholders. That was the easy bit. Trying to get to the bottom of how risky banks are, and so how much capital each requires, is now top of regulators’ minds. Beyond further denting the sector’s profits, the outcome of their review threatens to introduce risks of its own.
Although seemingly arcane, the level of capital banks need is central to their profitability—and, they argue, to their ability to finance the real economy. With interest rates close to zero in much of the rich world, borrowed money is cheap for banks, if not virtually free. Shareholder funds, on the other hand, cost them around 10% a year—the return typically demanded by investors for agreeing to bear the first losses in a sector with a tendency to blow up. So the debate between bankers and their watchdogs...Continue reading
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