Leverage ratio best as a backstop

The governor of the Reserve Bank of Australia, Glenn Stevens, appears to side with the domestic banks in their critique of aspects of the global debate over bank regulation.

In a speech to Australian Business Economists in Sydney last night Stevens played down the long-term merit of a trio of big ideas churning their way through the international debate: leverage ratios, higher liquidity levels and credit controls.

Reprising a theme from a recent speech, Stevens stressed that "the most egregious behaviour [leading to the financial crisis] was mainly that of 30 to 40 globally active banks."

Stevens declared himself a sceptic on the basic leverage ratio that's emerging as a key regulatory tool, at least in key northern hemisphere banking systems.

Stevens said that he was not personally persuaded of the intellectual basis of the simple overall leverage ratio and offered a defence of the risk-weighted approach to capital embodied in the "Basel 2" approach to working out bank capital, which applies in Australia and Europe.

Noting that the leverage ratio was proposed as a "backstop" - not that many banks seem to be treating it that way - Stevens said that "provided it is suitably calibrated the leverage ratio will probably not do any great harm."

He warned, though, that "were it to be calibrated in a way that unnecessarily constrains the common or garden variety commercial bank it could be unduly costly.

"It will be sensible to ensure, as far as we can, that the proposed measures act effectively to constrain the worst excesses of the former without unnecessarily shackling the latter."

Stevens also cautioned on the likelihood of working out any feasible rules on lifting capital buffers when times are good in order to cool exuberant behaviour.

Apart from the difficulty of working out a mechanism for doing so in a timely way he suggested experience shows credit controls of this, or other kinds, do not really work.

Citing experience from Australia's highly regulated banking system of the 1960s and 1970s he noted that "private markets find a way of doing business outside the regulated sector", as indeed the so-called shadow banking system did during the 2000s.

Stevens noted at this point in his speech that if financial conditions are simply too easy, and interest rates too low, balance sheet regulation will not constrain credit growth.

This final point is the theme picked up in many other media reports today and being interpreted as another reminder to Australian readers that domestic interest rates will continue to rise.