Friday, December 31, 2010

The Politics of Basel III [2/2]

. Friday, December 31, 2010

Yalman Onaran of Bloomberg has a very good rundown of the major issues that remain in the ongoing Basel III negotiations. The headline says "Banks Best Basel" and that's how the article begins, but the story is really about how national regulators can't agree on how to proceed:

The committee’s most significant achievement, members say, an agreement to increase the amount of capital banks need to hold, won’t go into full effect for eight years. Other measures that regulators had hoped would prevent future crises -- liquidity standards, a capital surcharge on the biggest lenders and a global resolution mechanism for failing firms -- were postponed, allowing banks to escape the toughest rules that would force them to change the way they do business.

“There will be changes, but not fundamental changes to the banking model,” said Sheila Bair, who as chairman of the U.S. Federal Deposit Insurance Corp. sits on the Basel committee’s top decision-making body. ...

Banks also reached out to their home regulators, arguing that some rules would disadvantage them more than other nations’ lenders. That helped draw the battle lines inside the Basel committee, according to an account pieced together from interviews with half a dozen members who asked not to be identified because the deliberations aren’t public. Germany, France and Japan led the push for softening rules proposed last December and stretching out their implementation. The U.S., U.K. and Switzerland opposed changes or delays. (bold added)

The bolded portion is a big part of what my dissertation is about*. Other than that, the first thing to note is that, as I've repeatedly said on this blog, major overhauls to the regulatory state are just not in the cards. Basel III is a tweaking of the rules already in place, and as we see below, national governments are under no legal obligation to implement, monitor, or enforce them in toto.

The second important point from this excerpt is that these negotiating coalitions have been in place since Basel I, and it -- once again -- highlights that the popular perception that the U.S. was the home of deregulation while other countries had tougher rules is wrong. Not only is finance (and banking in particular) one of the most regulated industries in the U.S., but U.S. regulations are some of the strictest in the industrialized world. We see that in the Basel negotiations, where the U.S. is pushing for tougher rules, while Germany, France, Japan, and others (sometimes including Canada) want to weaken the regime. Switzerland has already decided that the Basel requirements are too lax, and have unilaterally imposed stronger capital requirements for their banks. The U.S. did this before the financial crisis, under Basel II (which the U.S. -- and many other countries -- never fully implemented).

The U.S. has also had some (very weak) liquidity requirements on the books for decades, something Europe and Japan have not done and resist now:

In addition to pushing for a higher capital ratio, Bair also argued for a global leverage ratio that would cap banks’ borrowing -- something the U.S. has had on its books since the 1980s. In July, when the committee was debating how to define capital, the U.S. agreed to some easing in exchange for Germany and France accepting a leverage ratio, some members said.

Proponents of the leverage ratio, or equity as a percentage of liabilities, say it’s a more straightforward way to prevent lenders from becoming too indebted. Unlike capital ratios, which are based on risk-weighting and can be manipulated, the leverage ratio counts all assets regardless of their risk.

This actually conflates two issues: the liquidity requirements themselves, but more importantly how to define capital. Under Basel III definitions the entire Japanese banking sector is essentially insolvent. In this case the devil is very much in the details. Liquidity requirements are much cruder than many capital definitions, which can be quite complicated and even sketchy, which is why some governments may just refuse to comply:

The EU may exclude the leverage ratio when it converts Basel rules into law next year. Several member nations have advocated dropping the rule, people close to the discussions said last month. A majority of the 27 EU countries oppose adopting the ratio, these people said.

So Basel III is just like Basel I and Basel II: it's about distribution, which means that it's about politics, not technocracy.

*Or what I think it's going to be about. It's still very early days.


The Politics of Basel III [2/2]
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