Basel lll: A missed opportunity?

BBC business editor Robert Peston on the new Basel rules

Here are a few more thoughts about Basel lll (sorry).

The first thing to say is that investors in big banks seem to like the new capital standards: since I disclosed on Thursday morning that the ratio of equity capital (core tier one capital) to assets would be rising from 2% to 7% (including the so-called conservation buffer), shares in the UK's biggest banks have risen between 5% (for Barclays) and 9% (for Royal Bank of Scotland).

Does that mean shareholders believe the new ratios will make the banks less risky investments? Is it a round of applause for the sensible prudence forced on the banks by Jean-Claude Trichet and his elite Basel guard of central bank governors and banking supervisors?

Well, that's unlikely. The investors to whom I've spoken are simply relieved that most big banks already have enough capital to meet the new standard. Which means that few banks will be coming to shareholders for more capital and most won't be constrained in their plans either to restart dividend payments or increase dividends.

Now if you believe that investors suffer from an endemic bullish bias, then you'll be concerned by their cheerfulness. It implies that shareholders in banks are still imprisoned by an ideology that some would say had been shown to be bankrupt by the great crash of 2008, namely that the premier measure of success for a bank is not whether it is rock solid but whether it is growing its balance sheet and dividends.

That is the ideology that still grips most bank executives - partly because it is an ideology that also allows them to extract whopping pay and bonuses. So you may also be concerned that a conspiracy of bankers and investors has gulled the Basel Committee on Banking Supervision into producing a new rulebook for banks' capital, liquidity and risk assessments that represents a futile attempt to strengthen the existing system, rather than engaging in more radical and effective reform.

Is there evidence for this depressing view?

First item in the case against the Basel Committee is all those warnings by banks that if they were forced to boost their capital reserves too much and too fast, that would limit their ability to provide vital credit - which could tip the global economy back into recession and reduce GDP growth forever.

There has been some fight back by regulators: the Basel Committee and the Financial Stability Board published papers over the summer arguing that bankers' fears that higher capital means global impoverishment had been exaggerated.

But it was clear from my conversations with central bankers and regulators that they were chilled to their bones by the idea that they might one day be accused of precipitating a second credit crunch as a result of their sanitizing zeal.

Result? Banks have a lengthy eight years to meet all the new Basel rules.

And the new rules, for most banks, give an official stamp of approval to most banks' current stocks of capital. These have of course been rebuilt and augmented over the past couple of years, in part thanks to the generosity of taxpayers.

But there was a coherent argument that a 7% common equity ratio should be the bare minimum ratio in a recession, and that banks should endeavour to build up their ratios to around 12% when the good economic times return (if they ever return).

To be clear, regulators and central bankers from the US, UK and Switzerland, the financial centres with the deepest knowledge of global investment banks, weren't a million miles from the view that the good-times norm should be circa 12%: as I've pointed out in earlier post, they were pressing for higher capital ratios but couldn't persuade the Germans, French and Japanese.

For what it's worth, the Ango-American-Swiss regulatory troika haven't surrendered completely: they have secured an agreement in principle that big banks whose failure would endanger the health of the financial system should be forced to maintain higher capital ratios than the 7% norm; but the precise increment for the risks that pertain to gigantism haven't yet been specified.

Second item in the case against Basel lll: there'll be no formal constraints on banks' dividend payments or remuneration in the transition period to full implementation of the new rules.

Third item, the new rulebook is - if anything - even more opaque and impenetrable than the Basel ll rulebook. Which means that it will provide endless scope for the brightest banks and bankers to game and arbitrage the system, fomenting new mini and major asset bubbles all over the place.

This opacity also means, of course, that the new rules may turn out to be more constraining on banks' riskier activities - especially their financial trading - than bankers currently appreciate. That's certainly what my regulator chums are endeavouring to persuade me.

We'll see.

Final item: the one new rule that might have acted as a serious permanent dampener on banks' tendency to irrational exuberance, namely a new non-risk-based leverage ratio, is being set at a level that will continue to allow banks to lend mind-boggling and record amounts (by all historical standards) relative to their capital resources.

Banks will be permitted to lend and invest 33.33 (recurring) times their tier one capital, a measure which includes capital with inferior loss-absorbing quality than equity or core tier one. It allows banks to be prone to bankruptcy from a 3% fall in the value of their gross assets - which does not seem altogether prudent.

What's more, the Basel Committee members could not even agree among themselves (largely because of the intransigence of the French) to make this relatively loose constraint obligatory for all banks: it's only an intention to make it such on 1 January 2018, subject to testing its impact in a "parallel run period".

In other words, Basel lll probably won't make the too-big-to-fail bank an extinct dangerous species: the world will still boast a decent (or indecent?) number of banks with balance sheets whose gross size is bigger than the British economy.

You can keep up with the latest from business editor Robert Peston by visiting his blog on the BBC News website.

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