Exactitud y aproximación de la matemática

Due to the role that bank capital plays and the level of its importance particularly with respect to the soundness of banks, the argument could be put forward that bank capital ought to be regulated.

Santos350_{, suggests that the reasons why bank capital ought to be regulated} can be attributed to three factors; the ever-important role that bank capital plays in promoting soundness in banks thus ultimately ensuring financial stability; that bank capital provides the allure of risk-taking incentives that banks cannot resist and end up undertaking; and finally, that bank capital plays a very important role in the corporate governance of banks and as such ought to be regulated.

On the issue of financial stability, it was suggested by Diamond and Dybvig351 that the aim of capital regulation was to enhance financial stability ‘which would otherwise be threatened in the event of widespread bank failures’352

.

This point raised by Diamond is indeed true and relevant but only to some extent. This is mainly because it is submitted that too much bank regulation and for that matter capital regulation has the potential to increase the unwanted scenario of shadow banking353 _{which has the tendency to} undermine financial stability within any given jurisdiction.

Lastra, however addresses the rationale for capital regulation from a different perspective. She suggests that capital regulation has become the main form of regulatory response which has been developed to counter the difficult practical issues that a ‘bank’s balance sheet structure’ presents354_{. Lastra} however, qualifies this assertion by stating subsequently that ‘the use of

350 _{J A C Santos ‘Bank Capital Regulation in Contemporary Banking Theory: A Review of the} Literature’, (2001) Financial Markets, Institutions & Instruments Vol 10, 41.

351 _{D V Diamond and P Dybvig, ‘Bank Runs, Deposit Insurance and Liquidity’, (1983) Journal} of Political Economy, Volume 91, 401.

352 ibid.

353 _{Defined as ‘…the system of credit intermediation that involves entities and activities} outside the regular banking system’. See the Financial Stability Board Report, ‘Shadow Banking: Strengthening Oversight and Regulation’ – Recommendations of the Financial Stability Board October 2011.

354

capital requirements as a regulatory tool is no panacea however. It is not a “cure” for all “the banking problems”’.355

The three features which in her opinion characterises a bank’s balance sheet structure thus ultimately providing a source of ‘financial fragility and the cause of regulatory concern’ are, the issue of low cash to assets due to fractional reserve banking; excessive leverage activity resulting in low capital to assets ratio and finally the maturity mismatches that typically characterises bank lending in contrast to its assets.

Thus, although the role of banks together with the capital they possess is very important on their own individual merit to warrant bank regulation, a distinct argument justifying the need for regulation of bank capital is arguably difficult to proceed on without it over-lapping the wider role of banks. This perhaps explains why the argument in support of the rationale for bank capital regulation presented by Lastra, seemed somewhat fused with the rationale for bank regulation.

The Report by the House of Lords Select Committee on Economic Affairs in the author’s opinion ensured clarity was not in short supply when it suggested that the rationale for capital regulation emanated from the three purposes that bank capital serve. The Report suggested that firstly, bank capital exposes shareholders to the risk of bank failure and as a result, capital requirements are necessary to counter any potential negative impact that bank failures may have on them thus ultimately enhancing ‘good risk management practices’356_. Secondly, the requirement on banks to ensure that an adequate level of equity-based Tier 1 capital is maintained to act as a buffer357 _{against bank} insolvency, presents banks with risk-taking incentives which banks capitalise on to maximise their profits. Finally, due to the loss-absorption qualities provided by Tier 2 capital (non-equity) in support of the loss-absorption qualities provided by equity Tier 1 capital, in the possible event of a bank

355 ibid. 356

House of Lords: Select Committee on Economic Affairs; 2nd Report of Session 2008-2009. ‘Banking Supervision and Regulation’ Report Volume 1 Chapter 4, paragraph 49 p21, 2 June 2009 United Kingdom.

357 ibid.

failure, it becomes absolutely necessary for bank capital to be regulated to enable it fulfil its role and function efficiently.

The Select Committee thus concluded that bank capital regulations were introduced primarily to ‘redress the natural tendency of banks to hold insufficient capital’358 _{through the undertaking of risk-taking incentives.} Although this arguably represents the main justification for the regulation of bank capital, it is submitted that the ever-present problem of creative compliance359 _{underscores the continued justification for bank capital} regulation, and ultimately bank regulation notwithstanding the distinct disadvantage where capital regulation may potentially exacerbate economic turbulence within regulated financial entities in a pro-cyclical way360.

Having earlier established the distinction between economic capital and regulatory capital, it is absolutely important to stress that for regulatory bank capital to be classed as eligible, it must be capable of falling into two separate but fundamentally distinct categories, i.e. Going concern capital or Gone concern capital.

In the publication ‘A regulatory response to the global banking crisis’361_{, Going}

concern capital was described as capital which was capable of absorbing losses while the firm continued to operate as a Going concern regardless of whether the firm was in a good state of financial health or experiencing financial stress, whereas Gone concern capital was referred to as capital capable of absorbing losses at a Gone concern stage thus ensuring or safeguarding the interests of depositors following bank insolvency.

Thus whereas the components of economic capital encompass credit risk

capital; market risk capital; operational risk capital;

business/reputation/strategic risk capital; liquidity risk capital and interest rate

358

House of Lords: Select Committee on Economic Affairs Report, (n356), para 51. 359

McBarnet defines this phenomenon as ‘….the use of technical legal work to manage the legal packaging, structuring and definition of practices and transactions such that they can claim to fall on the right side of the boundary between lawfulness and illegality. It is essentially

the practice of using the letter of the law to defeat its spirit, and to do so with impunity’. See

FSA, ‘The Turner Review: A Regulatory Response to the Global Banking Crisis’, March 2009, p17.

360

House of Lords: Select Committee on Economic Affairs Report (n356) 24 para 69.

361 _{FSA, ‘A Regulatory Response to the Global Banking Crisis’ Discussion Paper DP 09/02} March 2009, p66.

capital, economic capital may broadly be used362 _{in the following banking} concepts i.e. capital adequacy; risk-based pricing; credit portfolio management; capital budgeting; strategic planning; target selling and risk- based performance management. With this background insight, this thesis will dwell on the application of regulatory capital in respect of capital adequacy.