An interesting speech by Mr Stefan Ingves, Chairman of the Basel Committee on Banking Supervision, at the Institute for Law and Finance about Basel III. The answer to the question if we are done with Basel III, his answer is: ‘yes, we are done, but that doesn’t mean the work has ended. In some respects, it’s only just beginning. While finalising Basel III was an important milestone, work remains to (i) implement Basel III nationally in a full, timely and consistent manner; (ii) evaluate its effectiveness in reducing the excessive variability of risk-weighted assets (RWAs); and (iii) continue to monitor and assess emerging risks. My remarks this morning will focus on these three topics.’
Basel III: from 2010 to 2017
The Basel III framework is a central element of the Basel Committee’s response to the global financial crisis. The initial phase of Basel III reforms, published in 2010 (BCBS 2010(a)), focused on addressing some of the main shortcomings of the pre-crisis regulatory framework, including:
- improving the quality of bank regulatory capital by placing a greater focus on going-concern loss-absorbing capital in the form of Common Equity Tier 1 (CET1) capital;
- increasing capital requirements to ensure that banks can withstand losses in times of stress;
- enhancing risk capture by revising areas of the risk-weighted capital framework that proved to be acutely miscalibrated, including the global standards for market risk, counterparty credit risk and securitisation;
- adding macroprudential elements to the regulatory framework, by: (i) introducing capital buffers that are built up in good times and can be drawn down in times of stress to limit procyclicality; (ii) establishing a large exposures regime that mitigates systemic risks arising from interlinkages across financial institutions and concentrated exposures;
- and (iii) putting in place a capital buffer to address the externalities created by systemically important banks;
- specifying a minimum leverage ratio requirement to constrain excess leverage in the banking system and complement the risk-weighted capital requirements; and
- introducing an international framework for mitigating excessive liquidity risk and maturity transformation, through the Liquidity Coverage Ratio and Net Stable Funding Ratio.
These reforms have demonstrably helped to strengthen the global banking system. Since 2011, the Tier 1 leverage ratio of major internationally active banks has increased by over 65% (from 3.5% to 5.8%), while their CET1 risk-weighted ratio has increased by over 70% (from 7.2% to 12.3%). The bulk of this change was achieved by an increase in banks’ CET1 capital resources (from €2.1 trillion to €3.7 trillion). There has also been a corresponding reinforcement of banks’ liquidity: holdings of liquid assets have increased by 30% (from €9.2 trillion to €11.6 trillion).
Social benefits
There are also clear social benefits from these reforms. During the global financial crisis, the weaknesses in the banking sector were transmitted to the rest of the financial system and the real economy, resulting in substantial costs. Ten years after the start of the crisis, the global economy is still recovering from its effects. These costs include much higher public debt, increased unemployment and substantial output losses. To give just one example, a recent study estimates that the cumulative output loss resulting from financial crises is in the order of 100% of GDP in net present value terms.1 This output loss would probably have been much larger without the massive public sector interventions. The increase in banks’ capital and liquidity resources will help mitigate both the probability and impact of future banking crises.
But a major faultline remained in the regulatory framework, namely, the way in which RWAs were calculated. At the peak of the global financial crisis, a wide range of stakeholders lost faith in banks’ internally modelled risk-weighted capital ratios. The complexity and opacity of internal models, the degree of discretion provided to banks in modelling risk parameters, and the use of national discretions all contributed to an excessive degree of RWA variation. A growing number of studies by authorities, academics and the private sector pointed to a worryingly large variation in banks’ estimated RWAs (BCBS (2013a,b)). For example, one study found that banks’ reported capital ratios could vary by 50% for the same hypothetical portfolio.2 The loss in the public’s confidence in banks’ reported capital ratios clearly highlighted the need for tighter limits to the way in which RWAs are calculated and greater transparency.
Seek restore the credibility of RWA calculation
The recently finalised Basel III reforms seek to restore the credibility of RWA calculations, and as a result the public’s confidence in the banking system, by:
- enhancing the robustness and risk sensitivity of the standardised approaches for credit risk and operational risk, which will make banks’ capital ratios more comparable;
- constraining the use of internally modelled approaches, including by removing the use of the most advanced modelled approaches for certain credit risk asset classes and for calculating operational risk; and
- complementing the risk-weighted capital ratio with a finalised leverage ratio and a revised and robust output floor.
Collectively, the set of Basel III reforms addresses a number of shortcomings in the pre-crisis regulatory framework and provides a foundation for a resilient banking system that will help mitigate the impact of future banking crises and the build-up of systemic vulnerabilities. The post-crisis framework will also help the banking system support the real economy and contribute to economic growth.
Full, timely and consistent implementation: more than just words
But are these reforms enough, or does more need to be done? The answer depends in part on the extent to which the reforms are implemented in a full, timely and consistent manner across jurisdictions. To borrow the words of Goethe (1829): “willing is not enough, we must do”. The Basel Committee’s standards are global minimum standards. The Committee has no supranational authority, its decisions carry no legal force, and it cannot impose fines or sanctions. Rather, once the Committee agrees on a standard, its member jurisdictions are responsible for converting this standard into law or regulation. So internationally agreed standards that are not properly implemented will ultimately have no impact in practice. It is therefore imperative that the Basel standards are effectively implemented by all the Committee’s jurisdictions.
To this end, the Committee’s flagship Regulatory Consistency Assessment Programme (RCAP) monitors the timely adoption of Basel standards across jurisdictions and reviews whether standards are completely and consistently adopted by member jurisdictions. They also highlight any deviations from the Basel framework. As a result of the RCAPs, over 1,200 deviations were identified as part of the peer reviews focusing on the initial Basel III capital reforms. Two thirds of Basel Committee members have risk-weighted capital rules that are considered compliant or largely compliant with the Basel standards.
Looking forward, the RCAP will continue to play a key role in ensuring that the recently finalised Basel III reforms are implemented as agreed by the Committee. But let me stress three points.
First, in developing its standards, the Committee actively seeks the views of all stakeholders, public and private. For example, in finalising Basel III, the Committee consulted extensively with academics, analysts, banks, finance ministries, parliamentarians, market participants and trade associations as well as the general public. These views were duly considered by the Committee in finalising its standards. So there are plenty of opportunities for all stakeholders to express their views before the standards are finalised. The focus then should be on full, timely and consistent implementation.
Second, in endorsing the finalised Basel III reforms, the Group of Governors and Heads of Supervision (GHOS) has unanimously reaffirmed that they expect full, timely and consistent implementation “of all elements” of the Basel III package (BCBS (2017a)). So I take comfort that all of the Committee’s members keep this aim in the forefront of their minds during the implementation phase.
Third, the move to national implementation should not be read as an invitation to reopen policy issues and debates at a domestic level. While the varying legislative and procedural arrangements used to implement Basel standards across the Committee’s membership must be fully respected, it is concerning to see ongoing lobbying efforts by some banks and other stakeholders to undo or dilute aspects of the agreed Basel standards in some jurisdictions. The unsound expedient of adopting standards that fall below the Basel Committee’s minimums can only lead to regulatory fragmentation, and in a bad scenario a potential race to the bottom.
Just getting up close, as we like to say in Sweden, isn’t enough to shoot the hare.
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You can read the full speech on the website of the Bank for International Settlements.
Source: https://www.bis.org/
