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Back where we started

It’s Sept 2013, and we’re upon the anniversary of Lehman Brothers. Much editorial this week has been devoted to the perceived risk that still exists in the banking system.

Haven’t regulators reformed the markets?

Regulators have imposed a lot of changes to the way that banks do business and have even more changes still to happen. These changes are intended to avert another crisis. Whether they will work is up for debate.

Aren’t banks less exposed to risk now?

Banks are required to hold more Tier One Capital – issued equity and retained earnings – than in ratio to their assets than they were before, and they are required to hold higher quality and more liquid assets. If they trade derivatives they should be less exposed to the collapse of a counterparty. From next year they will be asked to stop any business that exposes the rest of the bank to risk in capital markets, such as proprietary trading, at least in the US.

Should I feel safer?

These rules are intended to cover the bases that left the market exposed to Lehman’s collapse. Most of the rules are not yet being enforced, although there is a certain amount of pre-emptive compliance by banks being reported. The exact circumstances of Lehman, a bank trying to sell debt massive amounts of debt that had little chance of being repaid, could be repeated. The difference now is that other banks should not be as exposed to the bankruptcy as they once were, and nor should taxpayers. However there are still some big problems to be addressed.

Whose problems are they likely to be?

Everyone’s. Firstly the risk of a bank being ‘too big to fail’ has increased, since many governments (including the US) encouraged bank consolidation after the crisis making banks bigger than ever. Secondly banks have begun to hide the risks they are take, such as through proprietary trading, by disguising them as other activities. That does not which suggest that attitude towards regulation is very positive. Thirdly, banks have been supported in their recently positive earnings by quantitative easing; things are not going to be so rosy when that stops. If banks are currently using central bank money to shore up their existing balance sheets they will be hard pressed to extend those balance sheets (as central bankers had intended them to be doing right now) once the tap has been turned off.

What might the new world look like then?

We can expect corporates to raise more funds from the capital markets and other non-bank sources. Banks may become slower, heavier beasts, funding smaller non-bank firms that take on the risks bank cannot carry. The world of shadow banking, which includes corporates supporting one another, where banks will not, is likely to grow. And, somewhere, in the near future, someone will try to hide their exposure to an enormous bubble; when the bubble bursts and they can hide no more, we will be back where we started.

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