eight years and bigger than ever: will Basel III help?

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.

7 comments for “eight years and bigger than ever: will Basel III help?

  1. September 13, 2010 at 11:55 am

    I don’t think this makes even a marginal amount of difference. What does 2.5% more capital mean when bankers can take a piece of garbage paper and call it an “asset”??? Cue the Jeopardy theme song…………..F__KING ZILCHO!!!

    A farmer can point at a fresh piece of cow dung and call it “landscape architecture”. Do you think the oligopolistic banker will put +2.5% collateral on his loan??? It’s a freaking joke man, worse than a joke.

    And the chances if another crisis in the time period of 8 years??? What exactly is “sophisticated” about this, ’cause I am missing it. You mean a more sophisticated LIE/b> ???

  2. Lawrence Baxter
    September 13, 2010 at 1:23 pm

    True, how the assets are classified can (and likely will) shape the final result enormously. But increasing the level of real capital and including a buffer with dividend and bonus restrictions does make some difference, surely?

  3. September 13, 2010 at 9:00 pm

    I think you are one of the good people on the front lines here Professor Baxter and I respect you. But I can’t share your optimism.

    First I would say there are almost always ways to skirt around these rules. But let’s make the naive/unrealistic assumption that these rules are rock solid and there are no loopholes. Do you think that “during such periods” restricting dividends and bonuses would be too little too late??
    Even after all the pains caused on middle and lower class America, Republicans and publications like the WSJ have tried their best to make pay czar Kenneth Feinberg look like the anti-Christ.

    Do you think during the next crisis they will just start chopping bonuses and dividends in Europe or America??? The British were trying to make America into cruel/heartless xenophobes for daring to propose the old seniors in Britain weren’t going to get their British Petroleum dividends…..

    I want to say “Yes, this is great, much less to worry about when these rules finalize in 8 years.” But I don’t see it.

  4. September 13, 2010 at 9:00 pm

    I think you are one of the good people on the front lines here Professor Baxter and I respect you. But I can’t share your optimism.

    First I would say there are almost always ways to skirt around these rules. But let’s make the naive/unrealistic assumption that these rules are rock solid and there are no loopholes. Do you think that “during such periods” restricting dividends and bonuses would be too little too late??
    Even after all the pains caused on middle and lower class America, Republicans and publications like the WSJ have tried their best to make pay czar Kenneth Feinberg look like the anti-Christ.

    Do you think during the next crisis they will just start chopping bonuses and dividends in Europe or America??? The British were trying to make America into cruel/heartless xenophobes for daring to propose the old seniors in Britain weren’t going to get their British Petroleum dividends…..

    I want to say “Yes, this is great, much less to worry about when these rules finalize in 8 years.” But I don’t see it.

  5. September 13, 2010 at 9:20 pm

    Ted, I agree that things could go the way you describe. I think this is virtually inevitable because we won’t come to grips with the fact that financial institutions have become too big, diverse and risky for safety, yet being so big their power is now overwhelming. So I suppose that unless we address that underlying problem all of these measures might turn out to be futile.

    I enjoyed your clip on Meredith Whitney, by the way!

  6. September 15, 2010 at 9:29 am

    Thanks I appreciate it. My two highest moments was being linked on James Kwak’s site and being linked on this site. Kwak even threw me a couple bones referencing me in some posts. I don’t get many compliments on my blog so it’s a big thing in my little world. I think it’s cause I don’t write enough of my own material. Too many links. I did write some nice long ones when I started, one on 401ks I thought was super good and another on a St Louis Fed paper on CAMELS to foresee bank failures. I’m just too lazy.

    If you liked the Meredith Whitney video you might like the Esther Duflo video from the TED conferences I have embedded now. Different topic but really good stuff and only 17 minutes. It’s rare to see someone of such high ability make efforts for the poor, so Esther Duflo is a super inspiring person, the type that gives you new faith in humanity. That’s shameless blog plug #1,001.

  7. Lawrence Baxter
    September 15, 2010 at 10:44 am

    I will look forward to seeing it. I’m all for shameless blog plugs and have done a few myself!

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