September 12, 2010
Basel III Happens Today
Posted by David Zaring

The Basel capital accord will be finalized today, and the whisper number requires increased capital for banks - perhaps as much as 8 or 9% for their tier 1 ratio.  The German and Japanese banks, which are stable, but far too big to fail, can't meet this number, and the US and UK banks already do, so there's a geopolitical struggle going on here.  But in anticipation of the announcement, it is worth remembering why the Basel process is important:

  • It is international cooperation that "works."  The capital accord, when first passed in 1998, changed the rules for the world's sophisticated banks, much to the detriment of the Japanese financial sector.  And it works without a treaty, or, really, head of state involvement.  I doubt there is a more important example of informal international cooperation out there.  And, fascinatingly, there's no enforcement mechanism.  None.  So Germany and Japan are fighting over requirements they could ignore as a matter of law (Basel is not law, and doesn't become hard law until enacted in the member countries). There is also no enforcement provided by the internal structure of the Basel process.  It is interesting to speculate why this international obligation matters so much, while, say, humans rights treaties are so frequently ignored.
  • It drives private sector activity.  One way the American housing market collapse created a global recession laid in the exposure of foreign financial intermediaries to that market.  They had gone in heavy for CDOs and ABSs because there was alpha to be chased there - and, critically, because housing assets got relatively generous treatment as capital on the books by Basel, helping the banks meet their capital obligations while getting a decent return.  Basel was created in part because US and UK banks, which had capital reserve requirements, were finding it difficult to compete with Japanese banks, which didn't, so there's another private sector influence for you.
  • It is getting complex.  Basel I - a plain-as-potatoes 8% tier one capital requirement - was set forth in a few pages.  Basel II - a complex internal model driven capital requirement with a minimum floor - was much, much more elaborate regulation.  In fact, it looked like a nascent international administrative law, with the rules all being made in Switzerland, rather than at the Fed, or BaFin, or the LSA.  The third iteration of the accord should be complex, but today's announcement will be simple, a number that will look a lot like Basel I.  In this sense, the regulators are moving away from value at risk and the internal models that have driven bank asset allocation decisions for the last two decades.

Anyway, I've written on Basel often.  Here and here are my basic takes, here's Basel during the financial crisis (it performed badly).  But you can see the stakes.  It is a cockpit for geopolitical struggle, it is a regulatory scheme to be arbitraged by the private sector, it is a novel form of international regulation.

Administrative Law, Financial Crisis | Bookmark

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