Just when momentum was starting to build for increased capital requirements as the core element of an approach that will reign in reckless risk-taking, Morgan Stanley effectively demolishes the idea.
In "Banking – Large & Midcap Banks: Bid for Growth Caps Capital Ask," (no public link available) Betsy Graseck, Ken Zorbo, Justin Kwon, and John Dunn of Morgan Stanley Research North America dissect the coming demands for more bank capital.
"In short, we think the demand for growth and access to credit will trump desire for unprofitable capital levels…
For the large cap and midcap banks, we expect normalized median common tier-1 ratios to come in at 8.4% and 10.0% respectively."
That's less capital than Lehman had just before it failed – 11 percent. (If you doubt this, read the transcript of the final Lehman conference call – link is in this NYT.com piece or try this direct link; see p.7, for example)
The Morgan Stanley logic is strong, up to a point – they are carefully anticipating the likely outcome of the national and G20 regulatory process that will address capital standards in detail over the next two years. This research report also makes explicit a great deal of the current thinking on Wall Street and explains much – including the attitude towards bonuses.
"Banks need and investors require banks to earn a positive return over their cost of equity to fund them…
These capital levels (8.4% and 10%) driven median ROE (return on equity) estimates of 13.7% and 12.0%, sufficiently over normalized cost of equity of 9-12% to attract investors."
In other words, if you don't allow banks to leverage (the flip side of keeping capital low), they won't be able to attract investors and won't be able to make loans – so you'll get less growth and fewer jobs.
