There are certain principles of banking that are timeless. For instance, capital is at the core of banking. It always has been and always will be, though some bankers, regulators and pundits lose sight of that from time to time. Are we in such a period now? It appears that way, as much of the banking industry is not taking seriously the true capital position of large international institutions.
This month marks my 30th year working for Louisiana financial institutions. I began representing the savings and loans in 1983. At the time, I had no idea that the S&L industry was hurtling toward a massive implosion, largely due to terrible federal policies regarding capital. The Federal Deposit Insurance Corp. website has a section on the chronology of the S&L crisis. Some of that information seems instructive today.
In 1980, the Federal Home Loan Bank Board, the thrift regulator, reduced the net worth requirement (what thrift capital was called) for insured S&Ls from 5% to 4% of total deposits. The board also removed limits on the amounts of brokered deposits an S&L could hold. In 1981, the Federal Home Loan Bank Board permitted troubled S&Ls to issue "income capital certificates" that were purchased by the Federal Savings and Loan Insurance Corporation and included as capital. "Rather than showing that an institution was insolvent, the certificates made it appear solvent," the FDIC website notes.
In 1982, the Federal Home Loan Bank Board reduced the net worth requirement for insured S&Ls from 4% to 3% of total deposits. Also, instead of using generally accepted accounting principles, S&Ls were permitted to meet the low net worth standard with more liberal regulatory accounting principles. The regulatory accounting principles were a fraud and everyone knew it, but the imperative to gloss over the true condition of many thrifts drove regulators to adopt policies that postponed the day of reckoning.
On April 9, 2013, FDIC Vice Chairman Thomas Hoenig gave a speech that I strongly recommend bankers read. In this speech, Hoenig says things that many in the industry do not want to hear, but need to listen to. Too many regulators in the federal banking agencies have turned a blind eye to the inadequate tangible capital position of many U.S. and foreign international banks. The 2008 financial crisis has resulted in extremely harsh community bank regulations that make no sense in the real world, are counterproductive and/or hurt the consumer. Yet the tangible capital position of the large financial firms remains inadequate.
This is especially puzzling when we understand that ending "too big to fail" is a long way from reality. The thin capital of many of these large banks is all that stands between them and another taxpayer bailout. And yet we have Basel III, which is more complicated than Basel II, less transparent and increases reliance on flawed risk-based capital that will likely prove inadequate, as it did during the recent crisis.
In the S&L crisis, regulators manipulated capital in a vain attempt to prop up ailing thrifts. Today, regulators embrace Basel III's risk-based capital requirements assuming they can correctly predict the future risk of certain assets and that these measures will protect the bank and the taxpayer. So far, regulators have not required sufficient tangible capital to accompany the risk-based approach. Real loss absorbing capital at adequate levels is needed and should be embraced by all banks. Do we need to keep learning the same lesson again and again? Capital remains king and adequate tangible capital is a necessary and appropriate part of banking.
Read Hoenig's speech. Think about the S&L crisis and you will likely see the similarities. Bad policy decisions by Congress and federal bank regulators then and now are making many things worse and, in the case of capital adequacy, not stepping up to the proverbial plate.
Robert T. Taylor is chief executive of the Louisiana Bankers Association.