This is below the sector ROE (10.5%), even without taking into account extraordinary items (9%).22  Sixth, in terms of solvency, the common equity tier 1 ratio (CET1) held relatively stable in 2021, after increasing in 2020.23 The CET1 ratios of the main European countries’ banks also held relatively stable, meaning that in terms of its CET1 ratio the Spanish banking industry remains in last place. This difference owes largely to Spanish banks’ higher asset density, influenced by structural factors such as the more widespread use of the standardised approach to calculate asset risk weightings. Indeed, at December 2021, the leverage ratio of Spain’s significant banks (5.7%) was only slightly below the European average (6%). 20  The average cost of liabilities is the ratio of net interest expense to financial liabilities. 21  In 2021, the cost of capital increased over the first ten months of the year, from 6.4% at December 2020 to 10.8% at October 2021, and then fell back over the last two months, standing at 8.1% at year-end. Thus, the average cost of capital for the full year was 8.8%, in any case below the sector’s return on equity (ROE). 22  So far this year, the cost of capital has continued to fall, to 7.3% in March and 6.9% in April, below the ROE for 2022 Q1 (11.7%).
Regulation must not stifle markets but seek to make them work better. In the financial sector, this means a judicious mix of rules and incentives for stronger capitalisation, more effective risk management, better transparency, and sharper market discipline. This has been central to the approach taken by the Monetary Authority of Singapore – never hesitating to impose high standards of prudence and financial discipline but always careful to do so in a manner that does not undermine enterprise and innovation. 11. Financial innovation – especially in derivative products – has been blamed as a cause of the crisis. This is not quite correct. Innovation has been a feature of finance for decades. The crisis was caused fundamentally by failures in macroeconomic policies and financial supervision. Monetary policy was too easy for too long in too many countries. This led to low interest rates and lax lending standards that precipitated unsustainable housing booms, mainly in the United States but also in other countries. Financial supervision failed to detect and correct the build-up of leverage in the system, especially in the shadow banking sector. Complex financial products obscured the risks in sub-prime lending and transmitted these risks across the financial sector. As Edwin Truman from the Petersen Institute puts it, “Financial engineering contributed to the market dynamics once the crisis got underway, but it was not ‘the cause’ of the crisis.” 12. Regulation should therefore not restrict financial innovation but seek to create conditions in the market that promote effective risk management.