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Basel II—The work goes on despite the crisis

Basel Committee | Basel II - the work goes on despite the euro crisis and sovereign debt issues Anthony Harrington

The crisis in the euro and the general anxiety in the markets over sovereign debt issues have caused many market watchers to take their eye off the Basel Committee on Banking Supervision’s work on revamping the Basel II standard. However, the market hysteria over government debt has not deflected the Committee from its efforts to raise the resilience of the banking sector. As the BCBS puts it: “The over-riding objective of the Committee’s reform agenda, as endorsed by the G20 and the FSB, is to deliver a banking and financial system that acts as a stabilising force on the real economy.”

The Basel rules certainly didn’t have much impact in securing that objective once things started to come unglued, but the BSCS is optimistic that this go round it is moving in the right direction.

In a recent speech, Stefan Walter, Secretary General of the Committee, set out the key elements of the reform the BSCS is proposing for a revised Basel II. They are:

  1. to try to ensure that all material risks are adequately integrated into the capital adequacy requirements that banks must meet
  2. that banks have sufficient high quality capital to absorb all losses arising from the totality of risks
  3. a technical point about credible leverage ratios that would help to contain the build up of banking sector wide leverage
  4. to get banks to think in terms of counter cyclical capital buffers and forward looking provisioning so that they are not knocked over by major shocks
  5. the introduction of minimum global standards for measuring and controlling liquidity risk
  6. strong regulation and supervision of systemically important banks, with a strong supervisory review process
  7. improved market discipline with good disclosure of a bank’s risk profile and capital adequacy
  8. a practical set of approaches to improving the management of cross border bank resolutions

It is a very big agenda and you would be very hard pressed to find anyone who would want to throw out any of the BSCS’s key provisions. However, as a quick glance down the list shows, the BSCS’s interests are a bit bound up with yesterday’s battles. There is no mention here of the issue of “too big to fail,” or whether banks should be broken up so that their retail deposit taking side and their “casino” money market operations have solid walls between them. In fact anyone reading the US Financial Services Bill and then looking at the BSCS’s ruminations will feel that they are in two very different worlds.

Much of the BSCS’s effort is bound up with improving the way banks model their own risks, the competence of regulators to assess those risks, and the processes that should be in place to see that it all ticks along. The politicians, by way of contrast, are focusing more on forcing some major external constraints on banks, not in asking them to sharpen up their modelling!

Where the BSCS and the politicians are on common ground is that both want systemically important banks to be subject to much tougher standards. For the BSCS, this tends to come down to increased capital requirements for trading book activities, counterparty credit risk and complex securitisations and re-securitisations. One suspects that the BSCS’s final recommendations, when they are complete, will be salutary in promoting banking health, but the BSCS may just find that the market it has set out to regulate has a rather different shape to it when the politicians are done…

Further reading on derivatives regulation and financial regulation

Tags: banking , Basel Committee on Banking Supervision , Basel II , capital adequacy , capital buffers , pro-cyclicality , regulation
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