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July 31, 2017

Bank Capital: Mini-Skirts and Maxi-Dresses

Jonathan Zenios

When I was at school in the 1980s each time we were set an essay, some bright spark would invariably ask how long should it be. To which the (of course, male) teacher’s response invariably was:

An essay should be like a woman’s skirt – long enough to cover all the essentials but short enough to be interesting.

As for essays of the 80s so for bank capital requirements of the 00s.

Legend has it that this approach to essay writing was taken to its logical extreme in the Oxford University general entrance paper when an aspiring student’s answer to title “What is bravery???? was the one liner “This is???. No doubt this had the desired effect for the first student who used it, but you wouldn’t fancy the chances of the second one to try it.

For the world’s largest banks the extreme point was reached in 2008 when RBS supported a £2.4 trillion balance sheet with a Tier One ratio of 6.1%. Too short to cover anything but certainly interesting if only in a bad way.

While most of us end up feeling nostalgic about our schooldays whether or not we actually enjoyed them at the time, few people miss the financial crisis.

Things have changed a great deal for the world’s largest banks since 2008 and generally in a good way. For starters while still large they are all a lot smaller than they were – RBS’s 2016 balance sheet was one third the size of its 2008 one and its CET1 ratio was over 13%. They also make a lot less money than they used to but are much less likely to lose lots of money in the future (even if some, such as RBS again, are still over a decade later paying the price for past excess).

Regulatory change has forced banks to deleverage, narrow their focus, fund themselves in more stable ways and hold a lot more capital. They are undoubtedly safer and more boring or to put it in a way my English teacher would understand – more maxi-dress than mini-skirt.

  • Note 1: RBS reported figures – 2016 under BIS III; 2007-2008 under BIS II on a proportionally consolidated basis
  • Note 2: FSB study estimates CET1 ratio of 1.97% at end 2007 under BIS III rules