Laurence FinkAndrew Harrer
Laurence Fink, chief executive of the world's largest asset manager, isn't buying the argument that Basel III capital requirements and other regulations banks now face will cost them money and hamper shareholder returns.
Mr. Fink, the CEO of BlackRock Inc. , said Wednesday that he believes that banks with more capital should pay less for loans, which would help returns. Speaking at a Toronto event with Toronto-Dominion Bank CEO Ed Clark, Mr. Fink said regulations that force banks into more steady earnings business and away from high volatility businesses will also lead to a better valuation.
The consulting firm McKinsey estimated last year that the Basel III impact would be to reduce return on equity (ROE) by about 4 percentage points for European banks and 3 percentage points for U.S. banks, assuming all other things remain equal. Basel naysayers have also argued that banks will have to charge more for loans to compensate.
But Mr. Fink suggested all other things won't remain equal, a view that has backing in academic research.
"There is more negative talk, and no one's talking about the fact that markets are efficient," said Mr. Fink. Investors will "pay up" for banks with "more capital and more dependable streams, and that will create a higher multiple and stock price."
"I don't agree with those people who say that it's costly and it will deteriorate ROE," Mr. Fink said. "If markets are efficient it can actually improve ROE."
"I would also say if you have that amount of equity, and because of all the different rules you have a more dependable stream of earnings, maybe you can get banks to trade back up to a 13,14,15 PE."
Mr. Fink's contention on cost of capital has a basis in the Modigliani-Miller (MM) theorem on capital structure, which implies that "as more equity capital is used the volatility of the return on that equity falls, and the safety of the debt rises, so that the required rate of return on both sources of funds falls. It does so in such a way that the weighted average cost of finance is unchanged." That explanation comes from researchers affiliated with the Bank of England who earlier this year completed their own study on optimum levels of capital at banks.
They found that levels could go even higher than Basel III is going to push them.
"It is absolutely NOT self-evident that requiring banks to use more equity and less debt has to substantially increase their costs of funds and mean that they need to charge substantially more on loans to service the providers of their funds."
For his part, Mr. Clark said he is a "huge fan" of Basel. He said that if Basel did force banks to adjust their business models because capital costs more, that's not a bad thing given the public policy outcomes. And banks will cope.
"People will rebuild their business model. That's what people do."