Bank regulations spell trouble for the economy

Anti-crisis regulations of the banking sector have a dark side. Bankers claim they can slow down growth due to reduced lending as well as force banks to transfer business from one country to another. And what will Poland do with regard to the proposed solutions? 'It will act in a cautious manner', said Marek Belka, governor of the National Bank of Poland at the Banking Forum.

‚When I look at the bank regulations in the world I feel concerned. They aim at reducing the size of the financial sector’, said Marek Belka.

More capital – less credit

The most important regulation was to be introduced beginning from this year but it had not been agreed by the Committee on Economic and Monetary Affairs of the European Parliament until the end of February. It is about higher capital requirements for banks and stricter quality criteria for capital as well as the introduction of new capital buffers.

Capital of the highest quality, CET 1, is to cover 4.5 percent of risk weighted assets and together with capital conservation buffer and countercyclical buffer – even 9.5 percent. It is common knowledge that at present banks find it hard to increase capital. Some of them, e.g. Unicredit, Pekao’s owner or Portuguese BCP, Millennium’s owner, have issued shares in the recent years. But they sold them very cheaply. So they have another possibility, i.e. decrease risk-weighted assets.

And that is what banks are doing right now. ‚Because of stricter capital requirements over 100 American banks have noted a decrease in the credit supply and its shortage in the US economy can be estimated at 374 billion euro’, Krzysztof Kalicki, President of Deutsche Bank Polska said at the Forum. According to estimates presented by him, all the regulations, including the obligation to increase liquid assets (LCR) and ensure longer-term funding (NSFR), will slow down economic growth in the USA by 0.05 to 0.5 percent annually and by 2015 GDP will be  lower by a total of 3.2 percent. In addition, 7.5 million Americans will lose their jobs worldwide.

The simulations show that banks will also bear the cost as a result of which the average return on equity (ROE) amounting to 15 percent before crisis will go down to 10.7 percent when all the requirements have been introduced, i.e. in 2019. According to the same estimates, approximately 0.5 million people will lose their jobs in banks alone.

Split of banks

There is more, though. American banks will probably face a split up into commercial banking divisions and investment banking divisions. Former United States Federal Reserve Chairman Paul Volcker concluded that some actions taken by the financial system are not socially useful but are speculative in nature. The split is envisaged in section of the Dodd-Frank Act known as the Volcker Rule, which regulates the banking sector in the USA. The Act is to enter into force in mid-2014, however its provisions have been appealed and a court decision is now pending. This may slow down the process of splitting up banks.

‚Entering into force of the Volcker Rule will mean that investors in the USA will lose 90 – 315 billion dollars, the cost of loans between investment and commercial banks will increase by 11 billion dollars and transaction costs by 4 billion dollars’, Krzysztof Kalicki said.

British economist John Vickers and the head of Finnish central bank Erkki Liikanen put forward similar proposals in Europe. The point is to separate systemically important bank actions from those that are unimportant for the economic system. In February, British Chancellor of the Exchequer, George Osborne, who had initially opposed this concept, announced that the government would soon present a draft act reforming the banking system which will include provisions giving the regulator (the Bank of England) powers to split up banks. This law is to enter into force within a year.

“It will raise uncertainty among investors and, in consequence, banks will find it more difficult to raise capital which will lead to a situation where banks will have less money to extend credits to the economy”, said Anthony Browne,  Chief Executive of the British Bankers’ Association (BBA), as cited by Bloomberg.

Also in February the German government adopted a draft act which provides that banks will have to separate their retail operations from those that deal with trading in securities, bonds, currencies, derivatives and other financial instruments. The draft act also provides that limits will be imposed on these operations. If banks’ involvement exceeds the limits, the German Federal financial Supervisory Authority (BaFin) will have the power to split up institutions. Minister of Finance Wolfgang Schaeuble announced that 10-12 German banks will have to reduce their investment exposure or split up. Moreover, the German draft law envisages penalties for bank governing bodies if these provisions are violated – up to a 5-year prison sentence or EUR 11 million fine.

A package of acts would enter into force in 2014 and by July 2015 banks would have to complete the process of separating the retail division from the commercial division. The European Commission is also to address the issue of bank structure but not earlier than in September. It is planning to introduce uniform rules for splitting banks in the entire European Union.

Why a tax on financial transactions

Another regulation awaiting banks is a financial transaction tax (FTT), which is to enter into force at the beginning of next year but not everywhere in the European Union, only in 11 countries willing to introduce such a tax. ‚It is an experiment on a live organism of the banking system’, the NBP President said. He also quoted the German minister of finance who said that the tax was introduced to limit the number of transactions executed and in consequence the size of the banking sector itself. Because of the tax, high frequency trading for example will probably become unprofitable.

Poland is not among the countries willing to introduce the FTT and the Ministry of Finance has assured recently that it has no intention to adopt it. However, the present structure of the tax will affect Polish banks as they will have to pay it on transactions concluded with partners from countries where it will be in force. ‚The introduction of this tax in Poland would make banks incur annual costs of approximately 8 billion zlotys only on account of the purchases of treasury bonds or NBP bills’, said President of the Polish Bank Association, Krzysztof Pietraszkiewicz.

The banking union will enter through the back door

So far Poland has not made a decision on joining the euro area Single Supervisory Mechanism (SSM). If we joined it, three largest banks, namely PKO BP, Pekao and BZ WBK merged with Kredyt Bank would be subject to its supervision. Whether we join it or not, Polish subsidiaries of international banking groups will be covered by the mechanism anyway. ‚The banking union will enter our country through the back door, whether we want it or not, because 65% of our banking sector is controlled by banks with head offices located in EU countries’, the NBP President said.

Right now however the SSM project is evolving. ‚We are very interested in introducing the SSM (in the euro area countries) as regards the banking groups’, said Deputy Minister of Finance, Wojciech Kowalczyk. Why? The point is that currently our supervisory authority has to hold discussions with national supervisors in countries of origin of Polish banks’ foreign owners . If such discussions were held with a supranational supervisor, they would be much easier. The largest banks from the euro area and from countries willing to join the mechanism on a voluntary basis will be covered by the SSM. Non-euro area countries would have voting rights in the supervisory system, but not in the Governing Council of the European Central Bank that is to approve the supervisor’s decisions.

Any country concluding that it has incurred damage as a result a decision taken by a body in which it is not represented could appeal to the European Banking Authority (EBA) where all EU countries are represented. Wojeciech Kowalczyk said that the appealed decisions would be voted there in accordance with the double majority mechanism. He added that provisions had been agreed that would not permit to transform WSE-listed banks into branches. It had been feared that parent companies could have the right to do so and exercise this right to avoid supervision by the Polish supervisory authority, e.g. if they wanted to withdraw capital from Poland.

Wait and see

NBP President Marek Belka said that Poland should not hastily take a stance on its participation in the banking union or in its specific planned areas. First, we do not know for sure what form they will ultimately take, second, we do not know if this is in line with our interest and third – as we are not defining the date of entering the euro area, benefits of joining the banking union would be limited. ‚We are moving forward but with the dignity of an old oak tree’, the NBP President said.

One of the biggest benefits to be gained by all crisis-affected euro area banks are liquidity operations of European Central Bank. The ECB provides banks of Portugal, Spain or Italy with cash without which some of them would actually prove bankrupt. The question is whether the ECB would provide liquidity to non-euro area banks in a crisis if non-euro area countries joined the banking union? That was postulated a few months ago by the European Bank for Reconstruction and Development. ‚Everybody is silent about it in all the languages of the euro area’, Marek Belka said.

What is urgently needed

‚Poland should introduce a system of bank resolution, and establish a systemic risk council to address macroprudential supervision’, claims the NBP President.

These are the two subsequent elements of the banking system reform gradually implemented worldwide. The purpose of resolution is to give the supervisory authority the power to take control over a distressed bank, segregate bad assets, dispose of good assets and then the institution itself could continue operations and wouldn’t be rescued with taxpayers’ money.

Such a draft act elaborated by the Bank Guarantee Fund and approved by the Financial Stability Committee has already been submitted to the Ministry of Finance. Deputy minister Wojciech Kowalczyk told Financial Observer that work on the draft act would be completed by the end of March and then it would be subjected to interministerial consultations which may take a few months. ‘When we have the resolution act, we will have grounds for negotiations in the event of a crisis in banks that have their subsidiaries in Poland’, Marek Belka said.

On the other hand, the systemic risk council would carry out macroprudential supervision. ‚The council is to predict all economy-related threats. It is not only about what is going on in the banking system’, said the NBP President. The council would be composed of representatives of the National Bank of Poland, the Ministry of Finance and the Polish Financial Supervision Authority (KNF) and head of the Central Statistical Office.

If it is established it would deal with issuing recommendations applicable to the whole market, e.g. to the entire banking system. It would be a counterpart to the European Systemic Risk Board (ESRB) and thereby a partner for negotiations. The European Systemic Risk Board was established in 2010 to counteract systemic risks to financial stability in the European Union resulting for example from links between financial institutions, markets as well as macroeconomic and structural conditions. Minister of Finance, Jacek Rostowski said not long ago that the MoF will take up work on the act on the establishment of the Council.

Which regulations need to be thrown away

There are more and more new regulations whose effects are hard to predict. Some of them have only been introduced in particular countries, others which are to cover the whole European Union are still at the discussion stage. ‚We have a multitude of regulatory initiatives which are not fully coordinated’, admitted NBP President. Similarly as in case of the financial transaction tax some of them would encourage arbitrate, namely to transfer and conduct business activity where the tax can be avoided. ‚Regulations are more and more sophisticated, so we are likely to have more and more sophisticated methods of circumventing them’, said Marek Belka.

The financial sector may have expanded too much on a global scale and we must slow down this growth. However, in Poland credit to GDP ratio is only 50 percent, while in Germany it positively exceeds 100 percent.

‚Poland isn’t overbanked. The slowing down banking sector will slow down growth’, said Lech Kukliński from the Warsaw Institute of Banking. Therefore, President of the Polish Bank Association requested legislators to consider which regulations do not necessarily need to be adopted in Poland.

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