Tuesday, September 14, 2010

Pen Meets Paper Sept.13'10

Opinion by Helge Nome
The Bank of International Settlements released the following to the world on September 12:
“At its 12 September 2010 meeting, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced a substantial strengthening of existing capital requirements and fully endorsed the agreements it reached on 26 July 2010. These capital reforms, together with the introduction of a global liquidity standard, deliver on the core of the global financial reform agenda and will be presented to the Seoul G20 Leaders summit in November. The Committee's package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. This reinforces the stronger definition of capital agreed by Governors and Heads of Supervision in July and the higher capital requirements for trading, derivative and securitisation activities to be introduced at the end of 2011.”

This made world headline news on September 13, but what does it all mean? And why is it important? First, The world has a pretty well fully integrated banking system at this time with the Bank for International Settlements (BIS) in Basel, Switzerland, as the regulatory hub. The banking system in most countries in the world now has a central bank that is legally connected to the BIS by legislation enacted in each individual country by its legislative body, such as Parliament in Canada. So, what you have is a kind of pyramid with our bank accounts underneath the footings of the beast and the BIS at the very top.
In layman’s terms, what the statement above means is that every bank in the world will have to keep more real money that it legally owns in the cookie jar in order to deal with sudden and unforeseen demands on money. You see, the world banking system is like an organism where huge amounts of money whiz back and forth every second, every day of the year. and no individual bank is allowed to let its account with the central bank, that keeps track of all the traffic, go too far into the red for very long. Without a full cookie jar, this can easily happen if a bank chooses to create loans for customers with little regard for deposits coming in, or the amount in its cookie jar. With one bank competing against another for market share in a dog-eat-dog world, this has been going on for a long time, resulting in the bursting financial bubble of 2007/8, when most people in the banking system panicked and hurriedly closed their money bags. That left the rest of us out in the cold where we are today.
All banks are going to have to increase their reserves to comply with the new requirements, but where is the money going to come from? Banks create credit money when they issue loans. But that money ultimately has to be tied to real goods and services in order to have any value. And there has to be a balance between the IOUs (which is what money really is) and what is owed in terms of goods and services. The banks, that created the financial bubble in the first place, see it as their God given right to create that money based on our God given duty to provide the sweat equity. Does that make sense?

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