Lesson 7: Banks’ profits were the problem – but are now the solution The shock to global banks’ profitability from the crisis has been sharp and severe (Charts 11). Judging by the response of banks’ equity prices, it may also be prolonged. Despite the recent recovery, the market capitalisation of global banks has fallen by $ trillion since the crisis began. In part, this is a reflection of banks’ business models having been reassessed. But it also reflects fears of future intervention to curtail banks’ risk-taking and profit-seeking. As unfashionable as it may sound, it is important that banks’ profitability picks up, sharply and durably, in the period ahead. From a systemic perspective, this is in the interests of both the financial system and the real economy. In the short term, lending by banks is a necessary condition for recovery in the real economy. And a recovery in lending is best achieved if banks believe new loans will be profitable. Some of the pre-conditions for profitable lending are already in place. For example, margins on new lending have widened fairly sharply, as new lending terms have been re-priced (Chart 12). In other industries, this would serve as the price signal inducing existing banks to begin lending and for new banks to enter the lending market seeking market share. Over the medium-term, global banks have a hefty repayment schedule to governments and central banks. Encouragingly, the flow of repayment has already commenced for some banks.
It will also contribute to the prompt detection of errors and deviations from targets, allowing banks to implement corrective measures and develop buffers as appropriate at an early stage. Banks should be encouraged to develop systems that allow managers to identify and understand the risks they are facing, consider the risks that may arise in the future, and respond promptly and actively to both. This will maximise the likelihood that they can continue to operate, even in the most difficult of conditions. Continued outreach and dialogue A second lesson I have learned through the development of Basel II is that communication with interested parties is absolutely essential. One reason we were able to incorporate leading practices into Basel II is because of the open and transparent process by which the Framework was developed. There has been a steady dialogue with the industry since the Committee began discussing revisions to the capital Accord back in 1999. Many of the firms represented here today contributed extensive and valuable feedback to the Committee on its proposals over the years. The Committee has tried to explain to the industry as clearly as possible its objectives and methods during this process, and in turn firms and industry associations have shown a willingness to engage in a serious dialogue to find practical, prudent solutions. This has helped supervisors to better understand the state of industry practice. Where we have found these practices to be reasonable and appropriate we have tried to incorporate them into the revised Framework in a sound manner.