Basel’s Bark May Be Slow to Bite

September 15, 2010


(Westlaw Business) – Between bank capital raises and media coverage, the Basel III era may be upon us. After months of anticipation, and more than a little dread on the part of banks, it is true that the Basel Committee on Banking Supervision (Basel Committee) has finalized the Basel III bank capital ratios and other measures. But not so fast. With history as guide, it’s apparent that there is a real gap between Basel-driven standards and actual implementation.

The Basel Committee, a group of central bank governors and regulators that facilitates global bank regulations, has finalized new capital requirements and slew of other measures. G20 leaders, however, will not sign off on the new rules until November. Also, it is important to note that Basel III is a set of international standards and best practices – not settled law or regulation. By way of analogy, Basel II was published in late 2005, but regulators in the United States, for example, delayed its implementation for more than two years. US regulators decided that only large internationally active “core banks” with total assets of more than $250 billion would be able to avail themselves of the Basel II’s advanced approaches to calculate their capital ratios.

In the U.S., Basel II is still being implemented. The current implementation timetable consists of a parallel calculation period under Basel I and Basel II, followed by a three-year transitional period. Internationally active “core banks”, including Citigroup, Bank of America, and JPMorgan, began the implementation plan’s parallel reporting period on April 1, 2010. The implementation plan calls for at least four quarters of parallel reporting before the banks enter the three-year transitional period. Moreover, U.S. regulators have reserved the right to change how Basel II is applied in the U.S. following a review at the end of the second year of the transitional period.

If Basel II is any indication, then under Basel III national regulators will likely reserve a great deal of discretion for determining certain aspects of capital requirements and implementing the proposed standards. Legal and regulatory regimes differ vastly around the globe and perhaps a degree of flexibility is to be expected. Additionally, national financial regulation passed in the wake of the credit crisis, such as the Dodd-Frank Act, will interact with Basel III and could require additional regulatory flexibility.

Even Basel III’s own implementation timetable gives banks plenty of time to comply with the new rules and capital requirements, in some cases until 2019. Even so, many banks will have to raise additional capital. Royal Bank of Scotland’s senior notes red herring prospectus, for example, lists the new Basel capital ratios in its “Recent Developments” section. The filing explains that the Basel Committee announced a package of reforms that increases banks’ minimum common equity or core capital requirements from 2% to 4.5%.

The tier 1 capital requirement, which includes common equity and other qualifying financial instruments, is set to be hiked from 4% to 6%. In addition to the 6% teir 1 capital ratio, banks will be required to maintain a common equity “capital conservation buffer” of 2.5%. According to Reuters, banks whose common equity falls below the capital conservation buffer will face restrictions by supervisors on payouts such as dividends, share buybacks and bonuses. Basel III’s capital adequacy requirements will be supplemented by a leverage ratio, a liquidity coverage ratio, and a net stable funding ratio.

Uncertainty and a fair amount of hand wringing preceded the finalization of Basel III. Deutsche Bank’s most recent interim report states:

The outlook for the Deutsche Bank Group continues to be influenced by the factors and trends… notably the uncertainty regarding changes in the regulatory framework….We continue to monitor closely the incremental capital demand from any potential bank levies, the Dodd-Frank legislation, the potential Basel III impact and other regulatory initiatives. We will participate constructively in the discussions with regulators to promote a coordinated global approach to banking supervision.

In the same vein, fellow global banking giant Citigroup included Basel III in recent disclosure. Citigroup’s “Business Outlook” section explains that the combination of Dodd-Frank and:

…the continued implementation of new minimum capital standards for bank holding companies, as adopted by the Basel Committee on Banking Supervision and U.S. regulators, has created significant uncertainty with respect to the future capital requirements or capital composition for institutions such as Citigroup.

The bank closes the section by stating that it will closely monitor these regulatory developments.

Under Basel III, national implementation by member countries will begin on 1 January 2013 and member countries must translate the rules into national laws and regulations prior to commencement. The more stringent capital requirements will be phased in from 2013 to 2019, which is quite a bit of time for the rules to be refined and clarified. Moreover, different regulators will oversee the implementation and adherence to Basel III in the participating countries, which seems to leave plenty of room for interpretation or variation between countries. Westlaw Business has prepared Related Resources links to keep your banking and regulatory practice abreast of latest Basel III developments.

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It is impossible not to see now that the financial regulators in the Basel Committee, trying to fend off a bank and a financial crisis, constructed an incredibly faulty Maginot Line.

It was built with lousy materials, like arbitrary risk-weights and humanly fallible credit rating opinions.

And it was built on the absolutely wrong frontier, for two reasons:

First, it was build where the risk are perceived high, and where therefore no bank or financial crisis has ever occurred, because all those who make a living there, precisely because they are risky, can never grow into a systemic risk. Is being perceived as risky not more than a sufficient risk-weight?

Second it was built where it fends of precisely those clients whose financial needs we most expect our banks to attend, namely those of small businesses and entrepreneurs, those who could provide us our next generation of decent jobs and who have no alternative access to capital markets.

Now with their Basel III the Basel Committee insists on rebuilding with the same faulty materials on the same wrong place and it would seem that we are allowing them to do so.

I am trying to stop them… are you going to help me or do you prefer to swim in the tranquil waters of automatic solidarity with those who are supposed to know better?

The implicit stupidity of the Basel regulations could, seeing the damage these are provoking, represent an economic crime against humanity!

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