Are there any riskless assets?: American Banker explains

Amid the recent string of bank failures, American Banker Washington Bureau Chief John Heltman joins Yahoo Finance Live to discuss how there may be no riskless assets anymore.

Video transcript

JULIE HYMAN: After the high profile collapse of SVB, Signature Bank and First Republic, the stability of the US banking system is still very much in question. "The Wall Street Journal" this week reported that large lenders in the US may face a 20% increase in capital requirements in the aftermath.

Risk weighting is one way that regulators keep tabs on the system. But in a recent piece, our next guest said there are no riskless assets anymore. And maybe there never were. Joining us now is John Heltman, American banker's Washington Bureau Chief.

And John, of course, my brain immediately goes to treasuries, which are the classic riskless asset. But in fact, turned out not to be riskless in a rising rate environment. So how should we, as investors and media who covers it, how should regulators think about what's on bank balance sheets now?

JOHN HELTMAN: Thank you for the question. And just to set the table for what we're talking about here. Bank capital is complex. So it's reflected as like you need to have X capital meet that in your good, which is how it works. But there's lots of different ways of slicing and dicing capital.

One of the advents of the several recessions ago or several bank crises ago was the Basel Committee. And they introduced this concept of risk weighting assets. And that is acknowledging that some assets are riskier than others. So if you are doing a strip mall in Cincinnati, that has one kind of risk profile versus a mortgage versus a Treasury security, and the idea is that you need to hold less capital or the capital you hold is commensurate with the risk of the underlying asset.

But that risk profile metric has a pretty bad track record. And so to answer your question, like, treasuries were the safe asset at this time. If you go back about 10 years, it was sovereign debt. If you recall in Europe, the Sovereign debt crisis around 2011. Mortgage backed securities were seen as very riskless leading up to 2008.

So my point with the piece was just that maybe we shouldn't assign zero-risk weights to anything because those things tend to get loaded up in the system. And then tend to go boom.

BRAD SMITH: So what does this mean for the broader environment in financial conditions right now?

JOHN HELTMAN: If policymakers were to take me up on my offer, the net effect would be higher capital requirements at banks. Because right now, there are things that they don't really have to retain capital against. Treasury is a good example.

The most liquid thing in the world is cash or supposed to be. But then, again, we just got past a debt ceiling crisis that would have deeply affected the value of cash. So as I said, nothing is really riskless.

JULIE HYMAN: If regulators change capital requirements or at least broaden the banks that would have to be abide by certain capital requirements, does that then take care of the how risky are the assets situation?

JOHN HELTMAN: Well, not really, like, yes and no. I think there's still a place for risk waiting to exist. It is still true that there are things that have higher risks relative to other things. And it is right for regulators to assign higher capital requirements for those things. And if you're a bank, you can decide for yourself, how much risk appetite you have. Risk equals growth. So if you don't take any risks, then you don't have any growth.

So each bank can decide for itself within reason how much risk it wants to assume. But I think that the idea that there are some things that are just safe has a pretty bad track record.

When things are considered safe and you don't have to hold capital against them, then it makes sense for you to hold more of those things. And when everyone's holding the same thing, those values can go up. And when that value exceeds the underlying secular value of an asset, as we saw with treasuries, banks got a bunch of deposits. It needed something to do with it. And they put it in something safe, which is long-dated treasuries.

The interest rate environment changed. And they found themselves underwater. That's the gist of the point there.

BRAD SMITH: American Bankers Washington Bureau Chief, John Heltman. John, always a pleasure to get some of your insights and perspective around the industry. Thanks so much for breaking this down for us.

JOHN HELTMAN: Thank you.