Can Europe and the U.S. Make Banking Safe?

Bank of America

Banking vulnerability continues to be a key issue in both the U.S. and Europe as policy makers and regulators on both sides of the Atlantic look to limit financial collapse and prevent taxpayers from bailing out banks.

In a recent interview with the Wall Street Journal, Sheila C. Bair, senior adviser with the Pew Charitable Trusts and former chairman of the Federal Deposit Insurance Corp.; H. Rodgin Cohen, senior chairman of Sullivan & Cromwell LLP; and Tim Pawlenty, chief executive of Financial Services Roundtable and former governor of Minnesota, each spoke on the topic of financial security.

Bair said there is still a lack of regulation and oversight on the financial industry, pointing to the need for further capital controls as a point of concern. “I think there are a number of outstanding rule makings that haven’t been finished yet. At the top of my list would be the proposed rules to strengthen capital requirements,” she said. “Excessive leverage is almost always a key driver of any financial crisis we’ve ever had, and the rules themselves allowed a lot of leverage.”

Pawlenty highlighted the conflict between the desire to prevent leverage and the need to lend. Commenting on the awkward clash between regulatory realities and political convenience, Pawlenty said: “Banks and other lenders are put in the position of getting pressured by regulators and overseers to make responsible loans and do rigorous and appropriate underwriting, on the one hand. And on the other hand, you have people in the political arena saying, ‘Hey, make more loans.’”

Europe is also having a debate on banking safety as it attempts to institute the long-vaunted banking union. Germany is adamant that rules be clearly defined for the dissolution of banks from the outset in order to spare German taxpayers from taking on weaker nations’ failing institutions. However, the U.K. and other countries want more freedom in determining the process for failing banks, rather than cede too much autonomy to a central banking authority; Germany feels this path would put some nations’ banks at a competitive disadvantage.

Also up for debate is how and in what order investors are affected should their bank fail. The current proposal says shareholders, then junior bondholders, senior creditors and, in exceptional cases, depositors with more than 100,000 euros bear the costs of failure.

In the U.S., the 2010 Dodd-Frank Act is supposed to alleviate these problems, as are the major banks’ current proposals to set up a debt-to-equity ratio to manage risk. However, the law has posed problems in its implementation.

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