Bundesbank chief opposes bailout funds for banks

FINANCIAL REGULATION should be strengthened by improving existing rules on how much capital banks must hold rather than by capping the size of banks or setting up bailout funds, the head of the German Bundesbank has said.

Speaking at Trinity College Dublin, Dr Axel Weber, a member of the European Central Bank’s governing council, criticised US plans to limit the risky activities of banks and to cap the size of the institutions. The plans would be “the most severe intervention” by a regulator in the sector, he said.

Such a move could lead to an unregulated “shadow banking” system where riskier investment banking, hedge funds and private equity firms’ activities would be forced outside regulated banking.

“Whether the resilience of the system at all is improved by that, I have some doubts,” he said, addressing the Financial Services Ireland (FSI) annual lunch.

“It could actually be that all the risky business takes place outside the regulated sector, and then we would kid ourselves and be under a false sense of security.”

A “much better” option would be to force banks to hold more capital by improving existing Basel rules, said Dr Weber. Discussions on the exact level of capital to be held by banks would be concluded by the end of the year, he said. “The key is to promote a more resilient banking sector by raising the level, the quality, the consistency and transparency of capital.”

Retail or “utility” banks may not have to hold as much capital, as they do not engage in risky investment activities, he said, while systemically important banks should have to hold “a capital surcharge”.

“It would make it less attractive for banks to become systemic, so you would put a brake on the growth of the balance sheets.”

Dr Weber said he was “not that keen” on a bailout fund for troubled banks, as it would not solve the problem of moral hazard – where banks act differently as they are not fully exposed to risks they assume, because they will be bailed out. Such funds “are never large enough”, he said, and the taxpayer is then forced to intervene, increasing the risk of moral hazard.

Most governments are under pressure to introduce a tax or levy on banks to force them to pay for the cost of the crisis, he said.

“Governments strongly want to go in the direction of such a tax – I think quite rightly that it will come as an ex poste instrument to deal with the cost of the next crisis.”