- Regulators have been successful in pushing banking systems to build much stronger capital bases than before the 2007 financial crisis
- Banks' limited capacity to use their enhanced capital bases without breaching minimum regulatory requirements undermines the benefits of having a stronger capital base
- S&P Global Ratings believes that banks' procyclical behaviors and exposure to confidence shocks might not have improved as significantly as expected
Despite having much stronger capital bases than before the financial crisis, banks around the world remain exposed to capital-related confidence shocks, according to S&P Global Ratings' Most Banks Don't Need More Capital, But The Flexibility To Use It In Times Of Stress.
"This apparent paradox reflects the effectiveness of the significant increase in minimum regulatory capital requirements in ensuring that systemically important financial institutions (SIFIs) have enough bail-in-able resources to absorb stress losses in a resolution," said S&P Global Ratings credit analyst Bernard De Longevialle. "However, at the same time, the higher requirements have also lead to a parallel shift in what the market believes are the minimum capital levels banks should permanently respect to keep its confidence."
As a result, in period of stress, banks might react with many of the same procyclical behaviors that we've seen in the past. Current considerations by Europe's Single Supervisory Mechanism to split Tier 1 Pillar II requirements into a hard "requirement" and a softer "guidance" component may give welcome additional flexibility to Europe's large banks to absorb unexpected shocks without triggering confidence-sensitive coupon suspension.
Regulators have been successful in forcing the banking system to build a much stronger capital base than before the crisis.
This achievement should not, however, hide the fact that most of these capital resources would be available only as part of a resolution. Over the past six years, new forms of concurrent regulatory requirements have emerged in addition to going-concern risk-sensitive metrics. In assessing where large banks in Europe and the U.S. stand according to these metrics, we observe that their effective loss-absorbing margins above regulatory requirements have not improved on average since before the crisis.
International standard setters didn't intend for these regulatory buffers to be viewed as establishing new minimum capital requirements. However, as seen earlier this year, the perceived risk of restrictions on distributions to shareholders or hybrid instrument holders can spread to the wider credit markets.
A further increase in regulatory minimum capital requirements could have unintended consequences, but flexibility to use capital buffers when needed would in our opinion benefit the resilience of the world's banking system.