Rethinking how companies are organised and taxed is key to rebuilding after Covid-19.
Banks have a long history of overextending themselves and getting into trouble and for sure there will be future collapses of banks including some as a result of the current Covid-19 crisis. But the numbers will be lower in the current situation as a result of the reregulation of banking that has taken place since the financial crisis.
Banks now hold much more capital, have better liquidity and are less leveraged than previously. They are far more resilient but equally they are less profitable as they take less risk and have a higher cost of capital.
Given the undesirability for most bank CEOs and their shareholders of giving up short-term profits for long-term stability, it’s unsurprising that they needed to be forced down this road. Few would argue, however, against the advantages of being more resilient in an ever more unpredictable world.
What the current crisis has demonstrated is that many other institutions and infrastructures, including those in both public and private sectors, would benefit from the same resetting of the efficiency-resilience calculation.
Let’s start with the private sector. The efficiency attractions of just-in-time manufacturing and thinly spread supply chains have shown their weaknesses in the current environment with sudden border closures and spikes in demand that could not be met. Should they be more effectively regulated?
Champions of free markets will argue that the realities of bankruptcy for those that get it wrong is the only sanction needed and, furthermore, that if banks had been allowed to go under in the financial crisis they would not need as much regulation. But the reality of modern capitalism is that the disruption and social fallout from a large-scale corporate failure, or even worse an entire sector, is a price that governments are mostly not willing to pay. What this means is there has to be regulation.
The same approach needs to guide the thinking around the finances of corporates as illustrated by the current debate over tax deductibility of interest payments. In the low-interest environment that has existed since the financial crisis, and encouraged also by tax deductibility, companies have built up unsustainable debt levels as a way of boosting profits when markets are booming. The result is that many are now highly vulnerable to market shocks.
Encouraging companies to balance efficiency and resilience in a safer way should be the cornerstone of both regulation and tax policy changes. Next week's blog will look at how the same thinking needs to apply to government institutions and finances.
Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen
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