Opinion

Felix Salmon

Basel III: Grounds for optimism

By Felix Salmon
May 26, 2010

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.

Comments
2 comments so far | RSS Comments RSS

The response of the Canadian Bankers Association (http://www.bis.org/publ/bcbs165/cbac.pd f) bears out your summary to a degree. In several cases, though, they support their claims with cogent arguments – a fact you fail to mention.

They also level criticisms that go beyond the simplistic story of self-serving lobbying, among which are:

1. “Certain previously regulated activities may also move into the unregulated market, which could increase rather than reduce systemic risk.”

2. “Many of the proposed deductions, such as the deferred tax assets and counterparty/CVA deductions, would exacerbate procyclicality.”

Will Basel III really decrease systemic risk, or will it merely corrupt the last bastions of sound regulation?

Posted by Greycap | Report as abusive
 

Agree with the above comment – the banking issues have arisen from a series of failures which have in aggregate caused a systemic crisis of global proportions.

Many reasons – all valid contributors – sourced in the good old USA and supported by some European banks – need to be addressed: non-recourse lending for housing, honeymoon interest rates, lack of accountability in selling debt (through securitization) with inappropriate reward structures, CDO structures to slice and dice securitized debt so it is even less transparent with even lower accountability, rating agencies that rated it inappropriately, investment banks who gamed the rating system by hiring rating agency insiders, regulators who were asleep / unable to view issues in full context and to top it of OTC CDS’s growing to epic proportions to supposedly insure us all from catastrophy (OTCs resulting is an ever greater pool of exposure due to the need to enter a counteracting trade to cancel a position – with both positions remaining “live” like grenades – No doubt even more factors.

And the response? Tighten GLOBAL capital adequacy requirements for ALL banks. Forgive my cynisism however this appears to be be a one dimensional solution which helps level the playing field globally for all banks so we can all pay the price – as I sure we all know tighter regulation adversely impacts smaller banks more than large due to compliance costs, typically harder to obtain funds and more expensive etc and will have a greater impact in faster growing regions like Asia where institutions will need more capital to support future growth without this impediment. A suggestion that greater adequacy requirements will not slow down lending growth in ludicrous – it is a form of deleveraging.

How about some more targeted solutions for the problems – ban non-recourse loans for mortgages (so borrowers are more prudent), address issues of accountability (and reward) associated with securitization/CDOs, address rating agency issues, establish exchange traded mechanism for CDSs and maybe as per George Soros place some controls on whom can use them (look to limit the possibility of insured parties acrually wanting a failure!

Some thoughts to start with – Basel 3 seems well and truly removed from the key issues and also the jurisdictions which need to be fixed

How about -

Posted by APACreader | Report as abusive
 

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