There is much positive publicity about the new rules agreed upon at the Basel Committee. And there is no doubt that on their face they are much stricter than the old ones, requiring banks to double their level of real core capital and add a buffer of 2.5%. This means that, while banks could use the buffer in times of distress, they will face severe restrictions on dividend payments and other activities during such periods. It also means that leverage will be reduced and the scale of individual bank risk taking will be more contained.
Of course the immediate reaction of an industry spokesman in the US has been to complain that these measures would reduce the availability of credit and therefore slow down recovery from the recession. Such knee jerk responses are an old melody and they have been quite thoroughly refuted. But we should be aware that the battle is not over.
First, banks have up to eight years to comply. This is designed primarily to help the weaker French and German banks. Eight years is a long time given the current rate of crises cycles around the global economy.
Secondly, one may expect continued lobbying against the bite of these rules, not only up to their formal adoption by the G20 in Seoul, Korea, in November, but also during their implementation phase in each domestic jurisdiction.
Thirdly, the capital rules do not appear to address size. As we experienced during the global financial crisis, capital can disappear very, very quickly so even these new standards may not be enough to sustain an institution in a crisis. And the bigger the institution is the more complex it is likely to be and the worse it will impact the economy as it fails, ultimately forcing the political process to invoke “too-big-to-fail” measures.
So while the Basel capital standards are much more sophisticated that those currently adopted and are to be welcomed, we should watch their evolution carefully and not assume they will prevent failures on their own or remain as vigorous as they now appear.