Basel III: Europe’s Interest Is to Comply

On February 14, European Commissioner Michel Barnier and Federal Reserve Governor Daniel Tarullo both indicated their agreement to quickly give the Basel III accord binding force over, respectively, European and American banks. This is welcome. But even more important than the speed of adoption is that implementation should stay true to what the accord stipulates. At this point, and contrary to many perceptions in Europe, this goal is more likely to be reached by the United States than the European Union.

Basel III is the work of the Basel Committee on Banking Supervision, which includes 27 countries as its members (plus EU institutions and the International Monetary Fund as observers) and is hosted by the Basel-based Bank for International Settlements with a small permanent secretariat there. It is the crowning achievement of the G-20′s financial regulatory agenda in the wake of the Lehman Brothers collapse in 2008. Other prominent initiatives have had only partial or mixed results, including the centralized clearing of over-the-counter derivatives, accounting standards convergence, the regulation of rating agencies, or restrictions on compensation practices or regulatory havens. By contrast, Basel III has moved ahead quickly and can be labeled a clear success for global financial regulation. It is already making a difference, and a positive one, in the way the global banking system operates. Credit for this goes to the Basel Committee’s members and to its successive chairmen and secretaries-general since 2007.

Without going into all the details of a rather long text, Basel III makes the definition of regulatory capital much more rigorous; increases minimum capital requirements dramatically, from 2 percent to 7 percent for the key ratio of common equity to risk-weighted assets; tightens the methodology to weigh the risk of assets; introduces a minimum leverage ratio (capital to non-risk-weighted total assets) to mitigate the risk of manipulation of risk weights; introduces additional requirements depending on the financial cycle and the systemic importance of some banks; and introduces regulatory standards and ratios for banks’ liquidity profile.

The accord has been criticized from all sides of the financial regulatory debate. Much of the banking community, including the Institute of International Finance, has argued that the increase in capital requirements would greatly impede growth and that the liquidity ratios would harm market functioning. J.P. Morgan Chase’s head, Jamie Dimon, has lambasted the additional capital requirements for systemically important financial institutions, including his own, as “anti-American.” But third-party studies suggest that bankers have been exaggerating the negative impact, and that the standards’ adverse effects will be more than compensated by the benefits of additional financial stability for the system.

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