If US President Barack Obama and the Democrats are punished as brutally in the mid-term elections as seems likely, their handling of the banks will be one reason for it. The administration’s critics come from every point on the political spectrum but they agree about this: the banks pushed the country into a crisis, got bailed out and walked away scot-free. Bank profits are surging. The new financial rules, so voters think, have been shaped by the industry to spare it inconvenience. God’s work, as Lloyd Blankfein – chief executive and chairman of Goldman Sachs – put it, goes on. The only difference is that lending is suppressed while the banks recuperate – keeping the rest of the economy in the recession that the banks made in the first place. Federal Reserve chairman Ben Bernanke, the pre-eminent US regulator under the new Dodd-Frank structure, is more sanguine. He and other regulators will have the tools they need in future, he recently told the Financial Crisis Inquiry Commission. They are on the case. Maybe, but the more cynical reading is not so far from the truth. Once the crash began, it was already too late: Mr Bernanke and other policymakers had few good choices. Tim Geithner, the Treasury secretary, has said that when the financial system began to melt down, you could either punish the banks or restore their vital functions but not both – and he is right. It is good news that US banks’ are recapitalising and that their profitability is restored. The country would be in worse shape otherwise. And this too-easily forgotten point might yet be driven home. Should the housing market turn uglier, as it could, the US will get an extra lesson in the need for healthy banks.

The immediate priority is to avoid renewed financial stress and a second economic downturn. What should follow, however, once the economy is healthy, is far-reaching reform. This is not going to happen. When the recovery is secure, politics will move on, and the pressure for change will subside. Real change will then be possible but the political conditions for effecting it will have passed. Regulators have been working hard, but the reforms taking shape are too mild. Case in point: the Basel III capital-adequacy ratios, which central bankers met this weekend to fix and governments hope to finalise in November. These will improve on the existing rules but not by much. Ratios aside, critical issues of implementation remain to be addressed. The system the world is heading for will be better than before but still not good enough. The proposed new ratios strike a compromise between countries (including the US and Britain) that wanted tougher rules and others (notably Germany) that pressed for less stringency. The current minimum ratio of common equity to risk-adjusted bank assets is just 2 per cent – a figure that, with hindsight, should be viewed as laughable. This is to rise to 7 per cent under the new rules, including a proposed buffer of 2-3 per cent. When capital falls below the buffer zone, banks would have to curb pay and/or dividends. A recent paper by Samuel Hanson, Anil Kashyap and Jeremy Stein underlines a crucial point: to be any use, the regulatory minimum capital ratio in good times must substantially exceed the market-imposed standard in bad times: “Thus if the market-based standard for equity-to-assets in bad times is 8 per cent, and we want banks to be able to absorb losses on the order of, say, 4 per cent without pressure to shrink, then the regulatory minimum for equity-to-assets in good times would have to be at least 12 per cent.” The authors add that 4 per cent is a conservative estimate – cumulative credit losses at US banks between 2007 and 2010 were roughly 7 per cent of assets. Banks have been emphasising the costs of even modestly higher capital ratios. They have a point but they exaggerate. Estimates by the Bank for International Settlements and others suggest that the penalty in higher lending costs and lower economic growth would be small, and outweighed by the benefit of fewer crashes. The real danger in capital minimums that bind when they need to is not lower growth but regulatory arbitrage. The better the system works for regulated financial firms, the greater the danger that business will move to the unregulated. An appropriately strict regime for banks and other covered institutions would require new rules for the rest of the shadow banking system – including minimum collateral requirements for asset-backed securities regardless of the buyer. It seems we will get neither an effective capital-adequacy regime nor the further changes that would dictate. The Great Recession showed that financial regulation needed more than tweaking. Obscured by politics and special pleading, the lesson has still not been learnt.