The quiet victory of Basel III

By Felix Salmon
September 14, 2010

With a full news cycle now having been and gone since the Basel III accord was announced, a few things have come into more focus.

First, there will always be cynics and nay-sayers. Some of them are serious analysts who wanted a higher capital standard. But most are based on some variation on a simple, defeatist theme: “this doesn’t guarantee that there won’t be another crisis, and banks are still able to engage in dangerous behavior, therefore this is useless”. All I can say is that I’m very glad that the world’s central bankers didn’t feel that way and instead worked long and hard to try to put together a new set of standards which really will reduce systemic risk and strengthen the international banking system.

Of course, banking crises are always possible. But anything which reduces their likelihood is a good thing and Basel III reduces the likelihood of a banking crisis much more than all of Dodd-Frank put together.

Which brings me to Robert Peston, who’s upset at the media for not covering Basel more thoroughly. I’m sympathetic: I’m one of the few financial commentators in the mainstream media who, like Peston, has been banging on about this for a while, returning to the subject on a regular basis. And certainly, compared to Dodd-Frank, Basel III has received almost no press at all. But I part ways with Peston here:

There’s been little populist debate about how much capital and liquidity banks ought to hold for our own welfare. We’ve been presented with a fait accompli.

And most would argue that the media hasn’t exactly done a brilliant job in shining a light even on that fait accompli.

You might also ask where our [elected representatives] have been while unelected central bankers and regulators have trampled on territory that they would surely regard as their own, viz the fundamental laws that affect how [our] banks conduct their affairs.

So if you felt there had been something of a democratic failure here, you might have a point.

The way I see it, the Basel committees did a masterful job of depoliticizing the process as much as possible. The agreement is a win for Treasury, but Treasury was clever in not presenting it as such, because a large number of Republicans will automatically oppose anything that Treasury thinks is a good idea. The functionaries in Basel were generally mid-level central bankers, staying out of the spotlight as much as possible and putting together the best deal they could come up with. If politicians and the media had got involved, that might have made the process more democratic, but it would also have made it much more chaotic and quite possibly would have derailed any chance of an agreement at all.

The fact is that democracy simply isn’t the best possible way to construct a coherent regulatory regime for cross-border financial institutions. And the general public has every right not to feel the need to understand the difference between core Tier 1 and Tier 2 capital, or the finer points of how bank assets should be risk-weighted. This is something which central bankers, as a rule, know how to do — and the great news about Basel III was that they were given the freedom to go ahead and do it, while the power of the banking lobby was temporarily muted and in a period when anybody espousing a laissez-faire approach would automatically get laughed out of the room.

The main thing to take away from the Basel III announcement is that banks now need a lot more equity then they ever did in the past. It’s a little bit of a rhetorical stretch to say that the requirement for core equity has gone up from 2 percent to 7 percent, but it’s narrowly true all the same, even if the 2 percent requirement was never a central part of Basel 2 in anything like the way in which the 7 percent is the very heart of Basel III. And although the 7 percent requirement isn’t formally in effect, you can be sure that every bank in the world now feels the need to meet it. In fact, Credit Suisse said in a research note today that 8 percent is now the market standard for banks to be considered adequately capitalized.

Under previous administrations, financial regulations were quietly loosened, with disastrous results: think of the way that the SEC allowed almost unlimited leverage at investment banks in 2004, for instance. This time around, financial regulations are being quietly tightened. That’s a good thing and should definitely count as a signal achievement of the Obama administration. Even if the president himself isn’t going to make a major television address to trumpet it.


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Felix, there is an ironic thing in the last paragraph. The disastrous SEC decision you refer to in the paragraph actually permitted the banks to implement Basel II. And whichever way you look at it, the core of Basel II with its catastrophic over-reliance on cra ratings in foundations approach and securitization framework and failed risk management ontologies in e.g. IRBA has not disappeared.

Of course, it is going to be different this time, right.

Posted by acclaw | Report as abusive

You really need to have a chat with Per Kurowski over at the Basel-ine Scenario.

Posted by Uncle_Billy | Report as abusive

I put out this statement yesterday:

“Basel III is entirely irrelevant to the economic situation and even to the banks. Through things like minimum capital levels, the Basel II rules provided the illusion of intelligent design in the regulation of banking and finance. In fact, Basel II made the subprime crisis possible and the subsequent bailout inevitable. Now Basel III is being criticized as hurting the economic recovery. In fact, Basel III is a sideshow and is dwarfed in terms of its economic impact by changes in accounting rules and securities laws in the U.S. and EU. The only people who care about Basel III are the economists and regulators who are employed to support this ridiculous process.”

I would add to Felix’s comment is that the key thing about Basel II was the way in which the banks responded, namely with off-balance-sheet activities. The actually footprint in the marketplace of a bank includes its OBS emissions. Thus I contend that the changes in accounting rules in the EU and US are far more weighty in terms of changing bank behavior.


Posted by rcwhalen | Report as abusive

Basel I, II and III are progressively rotten at their core… and should not be defended.

First, because there has never ever been a financial crisis that has resulted from excessive lending or investments in what was perceived as risky, they have ALL resulted either from fraudulent behavior or excessive lending investments in what was perceived as not risky… and so that capital requirements for banks that are set higher when the official risk perceived by the official risk perceivers, the credit rating agencies, is high, and lower when the risk is perceived to be lower, are simply put, nonsensical.

Second, because there is absolutely nothing that says that the banks are there to be useless mattresses where to stash away some cash, but there to perform the important societal function of channeling bank credit to those who do not have access to capital markets.

Third, because the regulators gave up their role as regulators and arrogantly took upon themselves, by setting their risk-weights, to be the risk-managers of the world and, as a direct consequence, the banks went and drowned themselves in sovereigns and triple-As.

And the worst is seemingly that this Basel Committee is not accountable to anyone!

Per Kurowski
A former Executive Director at the World Bank (2002-2004)

Posted by PerKurowski | Report as abusive

We cannot just be negative.

There is no way to zero risk in banking, this is for sure. Basel iii is not perfect, but it is better than Basel ii.

The framework improves consistency and establishes risk management principles that are unique.

Yes, we will have another crisis in the future, this is also for sure. It is simple: Passing laws against robbery and murder has not stopped people from robbing and murdering.

To ban or not to ban taking risks? More strict banking rules can destroy the economy. Banks will not be willing to lend. What is next? Unemployment, bankruptcies, no mortgages…

Banks are (and must be) in the business of taking risks. Sometimes governments force banks to lend to at-risk borrowers, and decisions are based on government intervention, not risk management. Is there a framework against that? Can we blame Basel iii?

We can increase the likelihood that banks can absorb losses under certain circumstances. This is all we can do.

George Lekatis

Posted by GeorgeLekatis | Report as abusive

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