The year is 2020. Basel 6: how did we get here? - opinion

Author: | Published: 19 Oct 2012
Email a friend

Please enter a maximum of 5 recipients. Use ; to separate more than one email address.

Richard Reid
Over the last couple of months, it's become clear that there is a major rethink going on with some of the core elements of the regulatory response to the financial crisis. This appears to be driven by two main forces: first, the practical problems of implementation; and second, the measures' adverse impact on the financial system's ability to support economies struggling to recover from the downswing in activity. In the UK, the new Financial Policy Committee is well aware of its macro-prudential role and its twin objectives of resilience and growth.

It is in the nature of regulatory change that priorities shift. Immediately after any financial crisis the emphasis tends to be on stability and minimising taxpayer and consumer costs. But the further the crisis recedes into the past, the more other factors come in to play. That seems to be what is happening now. One of the focal points is Basel III and where the Basel process is going.

The Bank of England's Andy Haldane recently reiterated his concerns about overly complex regulatory requirements standing in the way of their effectiveness. His speech once again highlighted the difficulties of Basel III's reliance on risk weight calculations for determining capital requirements, as well as the danger to growth posed by banks deleveraging to meet their new targets.

Subsequently, the UK's FSA has introduced proposals which give prominence to absolute measures of capital coverage rather than ratios, as well as some modification to liquidity rules. These are to be accompanied by a higher degree of discretion on the part of the regulator during a prolonged transition phase towards final Basel III compliance. The European Banking Authority also seems to favour more emphasis on the quantum of capital. While this may put more pressure on banks initially to raise fresh equity, it may also help to restore investors' faith in the sector by setting a more transparent floor for valuations. Continuing uncertainty over the impact of regulatory requirements is often cited as a drag on the sector.

As would be expected, criticisms of the Basel approach have been rebuffed by those close to its development and implementation, arguing that at heart its objectives are sound. In addition, there seems to be a feeling that too much time, effort and political will has been invested in the process to ditch it now, and that to reopen the debate might render it impossible to reach a new consensus. There are fears that restarting the process may undermine progress towards global accord and a safer financial system altogether. No doubt its supporters would also argue that it is extenuating economic circumstances that have highlighted Basel III shortcomings, and that once we return to more normal circumstances the benefits of the new regime will be realised.

Nevertheless, the history of the Basel process suggests that it will evolve, with the likelihood that Basel III is not the end of the story. One of the leading contenders for taking over the helm at the Bank of England, Lord Turner, recently stated that regulators made a "mistake" in the transition to Basel II when the shift to complex, model-based risk weightings really began. In his opinion: "we should have maintained for each asset category an absolute quantitative minimum, using models to identify whether and where higher than minimum capital was required." In the course of 2013 the Basel Committee on Banking Supervision is scheduled to report on the consistency of risk-weighted outcomes. Lord Turner is not the only person to believe that the next iteration of the rules will underscore the shift away from complex risk-weighting towards absolute minimum capital levels. Given the recent flurry of high-profile comment surrounding the rules, perhaps we are well on our way to their next incarnation as Basel IIIa, Basel 3.5, or even Basel 4.

Dr Richard Reid is the chief economist and director of research at the International Centre for Financial Regulation

See also:

'Global regulators to copy UK's relaxed capital rules'

'Looking beyond Basel III'