Tuesday, 19 June 2012

BASEL III: The Problem with applying the same rules to everyone and everything

BASEL III: The Problem with applying the same rules to everyone and everything

Since the onset of this great financial crisis, and the mighty crunch of the nation’s credit supply, bashing bankers has been much in vogue. Many commentators have railed against the flaws of fractional reserve banking, its fiat money, its irresponsible lending, and its obscene encouragement of unrelenting all-consuming greed.  Criticisms which are not without some merit.

A significant part of the industry’s response to these problems has come in the shape of the new international regulatory framework for banks, known as BASEL III.  These new regulations are purported to strengthen the regulation, supervision and risk management of the banking sector, and so to prevent repeats of the financial crisis.  The most important of the reforms is the stipulation, due to be implemented in 2013 that Banks must hold capital that amounts to 7% of the assets. There are also to be tougher new rules about the amount of debt a bank may be permitted to take on to its balance sheet, and the amount of money it must have available to pay short term creditors.

Basel III may bring some small modicum of restraint to the banks of Europe and the US, where thorough reforms are needed.  As ever though, there is a catch: a business advisory panel to the G-20 group of nations has warned that new regulations will be disproportionately difficult to apply to developing countries, and that they will have “unintended” and “dangerous” consequences .

The panel pointed to the BASEL III requirement for banks to hold a certain amount of assets that are easy to sell in the event of a financial crisis, which will mean that banks have to hold high-quality corporate and government bonds. These are available in countries such as ours which have extensive capital markets, but hard to come by in developing countries , and simply non-existent in countries  following Islamic finance rules (which prohibit the traditional western fixed-income, interest-bearing bonds. They use Sukuks instead). And so the rule will unfairly restrict banking in developing economies, while giving an easier ride to those of western nations.
Similarly, the panel pointed out that the Basel III rules measurement of risk will also unfairly penalise developing market banks and companies. Western Banks will still be able to reduce their risk by purchasing credit default swaps, which are unavailable to banks in developing countries. 

Meanwhile, in our own country, we have seen publication of the report of the Independent Commission on Banking, chaired by Sir John Vickers, known – eponymously - as the ‘Vickers Report.’ The report contained several recommendations, including a proposal that UK banks should be required to hold capital of 10%, more than the 7% required by BASEL III. It would be a heavier restraint on banking activity which may well be appropriate for UK banks. However, to the annoyance of many, the Treasury intends to implement the BASEL III capital requirements, and not those of the Vickers Report.  Why? Well, the Treasury quite possibly in order to keep UK banks in line with the global norm.  But it is also quite possible that the UK’s particularly large banking sector will need heavier restraint than most, if it is to avoid trouble in the future

So, the international Bank regulations known as Basel III may make things unfairly difficult to for banks of developing countries, while letting our own institutions off the hook of the hardest reforms. So, instead of trying to make one set of rules apply across the board, why do we not allow a more diversified approach that takes account of local needs?