eirmoney | Banking, US and EU

Banking, US and EU

Posted by Anil Bagra | 04 March 2010

The highs and lows in last couple of years have prompted some serious thinking and hopefully action too.

Banking industry in the US is likely to undergo some fundamental changes to prevent future financial crises. The US government’s reform agenda for banking industry calls for stricter capital structures and contingency reserves. The reforms, unveiled by US President Barack Obama, restraints banks from taking excessive risk taking.

While giving the details, the president went on to describe the development as the biggest shake-up of the US system of financial regulation since the 1930s. Going forward, the Federal Reserve will have greater authority in monitoring the major financial institutions. Effectively, the new regulations are designed to clip money creation by privately owned companies, hoping to revert the process of excessive money being put into the system.

Certainly, the lack of oversight among finance institutions played its part in inflating the situation, but deep in the innards of financial regulations, but policy makers also need to acknowledge the misdeeds of capital allocation at their end.

The downturn started in the US but quickly took Europe under its fold. Governments in both regions, pressured to bailout the financial institutions, went to great lengths in fixing the situation. The US chose a policy of bailing out the banks and merged the failing banks with their healthy counterparts. However, the similarities end here. Although, national governments in European Union also bailed out the financial sector, politicians in this part of the world have taken steps which critics say are more prudent. Contrary to popular belief, world economies haven’t exactly come out of recession. However, the relatively better standing has given enough strength and courage to regulators to ask for a favour back. President Obama offered a sneak preview of the proposed reforms in the form of a financial crisis responsibility fee which is expected to rake in US$90 billion over the next 10 years. The funds garnered through this route will be used as a cushion in future crisis.

On the other hand, European Union’s stand to the bail out of the financial sector differed fundamentally right from the beginning. European countries didn’t go to the same extent of mixing bad apples with the good ones at the first place.

Back in October 2009, Bank of England governor Mervyn King took the lead in fuelling the ‘too big to fail’ debate and called for breaking the banks into smaller entities. The governor expressed concerns that merely following the capital requirements for big banks is not enough to safeguard taxpayer’s money. King dubbed the practice as the biggest moral hazard in history. This was in stark contrast to the practice of better capitalized banks taking over the troubled ones in the US. While government intervention is necessary in the financial mayhem, the practice of big fish acquiring small ones just creates bigger entities with their own set of inefficiencies over time.

In the US, the top tier banks have increased their balance sheets with subprime assets augmented as a result of the acquisitions. Among the prominent banks are Bank of America which acquired Merrill Lynch and JP Morgan Chase which gobbled up Washington Mutual.

If King’s comments back then renewed the debate to have a unique approach for tackling the situation, the European Union leaders have again made clear that they are not going to follow suit with the financial crisis responsibility fee. Instead, money can be raised by selling government stake in the banks which are now trading at better prices.