Stronger banks to stave off financial crises

Bankers do not like to lend money to businesses that overtrade or, put simply, have insufficient capital to support their turnover. Yet, banking is one of the businesses that overtrade in a big way. Banks’ capital is usually a small fraction of what they owe to their creditors who, in many cases, are small savers. So, when things go wrong, as has happened in some banks in the recent past, depositors are as much at risk of losing their money as shareholders.

The dramatic collapse of banking giants like Lehman Brothers in the US and Northern Rock in Britain has shocked regulators who may have become too complacent about the effectiveness of the checks and balances that should exist in the banking industry that has a vital importance for economic growth. Some banks in Europe, like Lloyds Bank in the UK and the Anglo Irish Bank in Ireland, owe their survival today thanks to taxpayers’ money that was pumped into them by governments fearing that their collapse would endanger the whole economic framework of the countries where they operated.

It is in this context that the European Commission is supplementing the strict capital requirements mandated by the Bank of International Settlements, known as Basel III, with new rules that will affect all European banks. The rules will see banks demanding that their shareholders increase their capital to a higher proportion of their assets in order to stave off any unforeseen crisis similar to the ones that have brought about the long-lasting global recession that started in 2008.

The sovereign debt crisis has shown that most EU economies still face massive risks should one or more countries default in paying their debts when due. The gradualist reform approach being adopted by EU leaders and international institutions like the European Central Bank and the International Monetary Fund needs to be accelerated if the EU economies are to show significant economic growth in the next few years.

Increasing the capital of banks to enable them to absorb any losses that may become inevitable if countries like Greece, Ireland, Portugal and, possibly, even Italy and Spain were to default, even if partially, is an important measure that should be implemented as early as possible. The European Internal Market Commissioner has rightly pointed out that “the financial crisis has hit European families and businesses hard. We cannot let such a crisis occur again and we cannot allow the actions of a few in the financial world to jeopardise our prosperity”.

The results of the second stress test exercise just conducted by the European Banking Authority were greeted with rather sceptical comments by the financial media that saw them as being too lenient because they did not envisage a sovereign default in any EU country – an event that today is considered as more than a possibility. The introduction of stricter capital requirements for banks is, therefore, desirable to calm the anxious financial markets.

Maltese banks are generally perceived to have stronger capital bases than many other EU banks of similar size. But the need for prudence can never be underestimated. The recently-published Financial Stability Report by the Central Bank emphasises the need for banks in this country to increase their provisions for doubtful debts and also to raise their capital to cater for “possible macroeconomic conditions which would negatively impact the domestic economy”.

Banks with a stronger capital base are a good guarantee to stave off another financial and economic crisis.