Major banks — those that are systemically important — don’t fail because of a capital shortage. They fail because they run out of liquidity.
That was amply clear in the 2007-8 financial crisis, and remains true today, even after far more stringent regulations have been imposed on banks, particularly in the European Union.
Those rules have created well capitalised and healthier banks, a far cry from pre-2008 days when they ran on thinner capital.
Most recently, Credit Suisse served as an unfortunate case study. It failed in 2023, not because it lacked capital — GlobalCapital has argued before that its AT1 capital, albeit imperfectly, served its intended purpose — but because it lacked timely liquidity.
The implication is that EU lawmakers and regulators should maintain their firm grip, but avoid fixating on capitalisation alone. The more important aspect for keeping banks healthy is whether they have holistic access to funding markets.
Regulators may have a reasonable case, should they decide to modify additional tier one capital. The most junior layer of debt capital could be made even safer in times of stress, increasing a bank’s ability to survive.
One change that could have a realistic impact would be to reduce the distance before an AT1 is written down or converted to equity. Currently, most banks are forced to do this by triggers when their common equity tier one ratio falls below 5.125%, with some at under 7%. Fewer than a handful of Swedish AT1s are set at 8%.
This seems a bit pointless when most European banks' CET1 ratios are in the double digits.
Raising AT1 triggers by a few percentage points to a higher single digit number could make it a more relevant metric in a time of stress.
However, a major overhaul of the AT1 asset class would mean a deeper change to European banks’ capital structure — probably the wrong thrust.
It’s not that we don’t need regulation. Banks are inherently prone to taking risks. But they are also the veins through which financing is disbursed in modern economies. In the EU, they provide 75% of corporate lending.
Unless the EU legislators are serious about completely redesigning the bank capital stack, including the subordinated debt layers, they should stop at recalibration of AT1.
European AT1s hardly go to pure retail investors, so the asset class does not face the same end-investor problem as in Australia or New Zealand.
Going further in changing what is not broken risks running against the goal of making European banks more competitive.
This is at a time when other jurisdictions such as the US and even the UK are attempting to charge up their economic growth by easing bank regulation.
What matters for bank safety is access to liquidity — from the very short end to long-dated financing.
That access needs to remain healthy. A regulator's holistic view of banks' access to all markets will be far more relevant and useful for European banks.
Post-crisis regulation has worked — European banks remained insulated from the US regional banking crisis.
So it's time to break free from focus on capital alone. When it comes to competitiveness, time is of the essence.