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As the Banks Celebrate Relaxed Requirements, Risk (for Everyone) Increases


Will these more relaxed rules cause another global fiscal crisis?

But the Basel Committee made another concession to the banks, allowing them to count not only cash and government debt securities toward that liquidity cushion but also other kinds of assets that aren't always very liquid in times of crises: some stocks, lower-rated corporate debt and yes, even residential mortgage-backed securities. Those will now count toward the Liquidity Coverage Ratio, albeit to a maximum of 15 percent of the total.

That's a potential problem – another sign of the weakening level of commitment on the part of global regulators to the question of reform more than four years after the financial system narrowly avoided a complete global meltdown. True, the compromise may have been driven by fears about banks being able to meet the needs of economies struggling to grow, but it's a risky quid pro quo. In a few years' time, odds are that these economies will have battled their way back to stronger growth. The new and more liberal guidelines on what represents "liquid" assets on bank balance sheets, however, are here to stay.

Investors will want to hope that the market rapidly begins to distinguish between banks that take advantage of this more relaxed policy in hopes of boosting shorter-term profits and those that move more rapidly to implement the new liquidity guidelines – not just according to the letter but to the spirit of the rules. If a bank is able to generate higher profits simply because it is skimping on this liquidity measure, those earnings can't be seen as being as sustainable on a risk-adjusted basis. They should be awarded a discount in the market.

It isn't even as if banks can guarantee that in return for this concession they will be able to fuel economic growth via lending. It isn't up to the banks to shape demand for capital; their obligation is only to serve as a gatekeeper and to strive to avoid making foolish loans. They can't prod a company to expand simply because it would be good for the bank and for the economy. The company has to perceive that it can increase its profits by hiring new people, expanding its geographic range of operations or investing in new products.

These moves make for great headlines for the banks, and will probably help those like Bank of America and Citigroup, which have experienced the biggest gains over the last 12 months, as they try to return to an even pattern of profit generation. But investors will need to continue to look past the rhetoric and even the numbers in search of the banks with the most aggressive approach to managing risk.

Editor's Note: This article by Suzanne McGee originally appeared on The Fiscal Times.

For more from The Fiscal Times:

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Banks and Builders:Can 2012's Winners Keep Rallying?

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