2017 has marked a turning point in banking regulation. Basel 4, the informal name of the post Basel 3 regulatory framework has been agreed and will be implemented in the next few years. In the US, a new Fed Chair and a business friendly government will begin to soften banking regulation. The banks which in 2008 were found to be fragile have been repaired and returned to regular duty. European banks, roughly 2 years behind the US in terms of cleaning up balance sheets are now adequately capitalized. Basel 4 will require all banks to further strengthen balance sheets, but not by much more. Bank CEOs will now focus on return on capital, not the raising of it. In China, regulators are perhaps half a cycle behind but are reining in reckless credit practices and stabilizing the banking and shadow banking system. In India, a newly inked (2016) insolvency law is being enthusiastic applied with some encouragement from the RBI. A decade of bank underperformance from QE and increased regulation will soon be behind us. Time to buy some banks.
This week, we have a number of monetary policy meetings to look forward to at the Fed, the ECB, the BoE and the Swiss National Bank. The Fed’s long telegraphed rate hike will come as no surprise. The ECB has already made its move on QE and is unlikely to say anything controversial this close to the holidays. Ditto the BoE, PM May has made some political progress and the BoE will want to let the momentum ride. The Fed, having not made any radical or significant moves could surprise in its statements and indeed being the only major central bank to have turned the corner on QE and rates, will be closely watched.
From a higher perch, central bank policy becomes slightly clearer. The crisis is now almost 10 years behind us and the case for continued use of analgesics is becoming more difficult to justify. Antibiotic resistance may be developing and the central banks will need to prepare for the next crisis. This means normalizing balance sheets and raising rates, if not for the strength of the economy, which has suddenly seemed more hale and hearty, then just to pack the parachute back in the bag. Rates are going higher. The long end of yield curves is another matter for inflation has been stubbornly low. Yet one suspects that the yield curves have overshot even the meekest of inflation expectations. Energy prices certainly are a risk.