September 12, 2010
The Most Important 7% In Finance
Posted by David Zaring

Basel III has been announced, and the number is 7%.  That's the amount of a member country's bank assets that must be held in reserve.  What does "held in reserve" mean?

The Committee's package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. 

What is this capital conservation buffer?  I assume the idea is that it could be cash, as opposed to stock.  But it has to amount to "common equity."  It's a sort of strange term, and a relatively new one in the Basel lingua franca.

There are some other details.  Full phase in won't happen until 2019, plenty of time for another banking crisis, somewhere in the world, to occur and send everyone back to the drawing board.  Basel explicitly contemplates that these capital requirements may be raised in boom times (countercyclical capital is supposed to be a good idea), but that's something that would need to be seen before it should be believed, and it would be raised a tiny amount, at least as Basel has declared it today.  And the capital can only include state money - a vexing question in international competition (where states sometimes identify "national champions" and subsidize them) - until 2018.

On top of the 7% will be an additional 1.5% Tier 1 capital requirement, these can be invested in other stuff, which will be risk weighted.  It was the generous risk weighting of housing assets that got so many foreign banks into the American housing market, and so the risk weighting is being reexamined, but that is a subject for another press release.

Tier 1 capital gets you to 8.5%, and then there's additional capital required, to get everyone to 10%, but since that capital can be placed in very risky assets, it isn't the subject of much attention.  

All of this has to be spelled out further, and my summary won't do much justice to the complexities of financial regulation.  Here's the Times.  Here's Reuters observing that European banks stocks declined in anticipation of the deal, because they'll have to lay on more capital.  And here's Felix Salmon with a pregame.

What are these pronouncements, a lawyer might wonder?  Are they a rule, or a guidance document, or a judicial decision?  In fact, Basel usually acts through press release (and sometimes through white paper).  The agreement by committee members is the "legal" "action," but it often isn't really memorialized anywhere except, in this case, here.  A press communique founded the committee in 1975 (or, at least, is the only public memorialization of the founding), by the way, so a press release announcing the capital adequacy rules is pretty consistent with the regulatory approach.

Administrative Law, Financial Crisis | Bookmark

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