Thursday, August 4, 2011

Regulatory Politics

. Thursday, August 4, 2011

The EU is working to implement Basel III:

New European Union rules designed to make the financial system safer would require banks operating in Europe to raise an estimated €460bn in capital by 2019 or substantially reduce their risk and balance sheets.

The draft proposals unveiled on Wednesday – which still need approval from the 27 member states and the European parliament – make the EU the first jurisdiction to start implementing the global Basel III capital and liquidity guidelines that were adopted last year.

The new Basel capital definitions hurt EU banks more than US banks, as they focus on improving capital quality by mandating more equity and less debt. As a result, EU banks -- still suffering from the crisis and recession, and on edge over sovereign debt holdings -- have to raise more capital than many of their foreign competitors. Predictably, they don't like that:

Industry groups in the UK and Germany warned that if the EU moves too far ahead of the rest of the world, its banks could lose out to international competitors and cut lending to the real economy. The projected capital shortfall, equivalent to 2.9 per cent of all the EU banks’ risk weighted assets, goes a long way towards explaining why EU banks are among the fiercest critics of the Basel III proposals.

Banks and some other groups argue that this will have an adverse effect on economic growth at a time when the EU can had afford it; while there might be some truth to that some new research shows that too much finance can actually retard growth, and that this is currently the case in some EU countries.

But the competitiveness argument seems to be undercut by this:

The EU’s draft proposals are likely to unleash months of heated debate, as member states and banking institutions haggle over the details. Some countries – including the UK – are still fighting for the flexibility to introduce national requirements that are higher than the EU minimums.

If competitiveness is such a big worry then why would any states have stricter requirements than required by international agreement? Note that this is nothing new; the US had stricter capital requirements than Basel I and II in order for firms to be considered "well capitalized" by the FDIC. And World Bank surveys conducted in 1999, 2003, and 2006 showed that 40-50% of countries had capital standards stricter than the Basel minima even before the financial crisis. The above heat map shows those results in 2006*. Since the crisis many countries have proposed or enacted new regulations that are tighter than their international obligations.

Most existing literature on regulation in finance, economics, or political science does not expect this type of behavior by governments**. Episodes like this suggest that we need to complicate our expectations about the ways that domestic and international politics interact, and the process by which governments set policy in a competitive global economy. It isn't unidirectional neoliberalism, even before the crisis. This is the focus of my dissertation research, so I'm sure you'll all be hearing plenty more about it in coming months. For now let's just say that this type of behavior follows the precedent of previous periods of crisis and regulatory reform.

*Darker colors indicate higher capital requirements. White is missing data. The Basel minimum of 8% is the light orange, as in the US. Note that much of the variation on this variable is in the developing world.

**Or the equivalent behavior of firms, which "over-comply" with capital regulations as a rule, albeit at different spreads.


Regulatory Politics




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