Basel III: Grounds for optimism

By Felix Salmon
May 26, 2010
put online for free -- that the central bankers seem to have the upper hand, right now, in the fight with the bankers.


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If you’re not a central banker and don’t even know any central bankers, chances are that you’ve never heard of Global Risk Regulator, a trade publication in London. But right now it’s very much worth paying attention to them, because their sources in and around Basel are unsurpassed. And it turns out, reading the cover story from their latest issue — which they’ve been nice enough to put online for free — that the central bankers seem to have the upper hand, right now, in the fight with the bankers.

Basel Committee chairman, Nout Wellink, who is also head of the Dutch central bank, and other regulators, have indicated that they will look closely at aspects of the proposed reforms that are causing most concern to bankers. But those in the industry expecting a delay in designing the regulatory framework, or that the recently-completed impact study would lead to an extensive re-write of the proposals – described by some bankers as “punitive” and “excessively conservative” – look likely to be disappointed.

The author, Melvyn Westlake, also has a handy one-sentence summary of what exactly Basel III is:

The proposed measures – dubbed Basel III – initially issued on December 17, include tighter definitions of Tier 1 capital, the introduction of a leverage ratio, a framework for counter-cyclical capital buffers, measures to limit counterparty credit risk, and short and medium-term quantitative liquidity ratios.

The banks are up in arms about all this, mainly because it will reduce their profitability and return on equity. But they can’t say that, so instead they’re falling back on the trusty old warhorse of “it will decrease lending”. The Basel technocrats, happily, seem unconvinced, although they have gone so far as to commission an official macroeconomic impact assessment to help counter the spin coming from the bank-lobby types at the Institute of International Finance. The IIF, of course, is already pushing as hard as it can:

Although the IIF’s own impact assessment is not yet complete, the Dallara letter says the initial results are “sobering.” They suggest that, “even in a scenario reflecting only the main proposals emerging so far from the Basel Committee – and not other, national initiatives – there would be a significant adverse impact on employment and growth in the US, extending over several years.” There would be a “more substantial effect in the Euro area,” the policy letter suggests, “reflecting the greater relative importance of banks in the region’s economy. Japan, whose banks were not directly involved in the crisis, would also be materially affected by the proposed changes.”

The impacts worldwide would be exacerbated by regulatory changes that go beyond the core Basel proposals, Dallara adds.

The problem is that all this noise coming from the IIF comes with zero credibility, because it’s the IIF’s job to say these things, whether or not they’re true. It’s also worth noting the “significant adverse impact on employment and growth in the U.S.” that the financial sector has already caused, over the past few years. The first order of business has to be to try to prevent that from happening again, even — especially — if it means a lower chance of another debt-fueled bubble. As Westlake puts it:

It is also clear that some modest reduction in growth during upswings in the business cycle would be acceptable to regulators if the proposed capital and liquidity framework also produced greater financial stability. If the cumulative 0.5% to 1.0% reduction in growth estimated by Dutch central bank economists is the price for getting a really resilient banking system, “that price is not too high,” Basel Committee chairman Wellink told the Financial Times newspaper in early May.

Regulators in the U.S. and Britain have expressed similar sentiments.

As a significantly positive financial reform bill makes its way through Congress and towards the president’s desk, then, it seems that there’s a good chance that it will be met with an equally positive set of new regulations coming out of Basel. None of these things is ever perfect, of course. But the big hole in the Senate bill is that it has very little to say on questions such as bank size and capital ratios and liquidity; it seems that Basel III is almost perfectly designed to fill that gap.

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