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The Basel Committee Moves Quickly on Basel III

The Basel Committee on Banking Supervision put on a burst of speed today, coming to broad agreement on many of the major outstanding issues regarding Basel III. (For more information on the goals, consequences, and process of the committee, please see my primer on Basel III.)

Frankly, I had expected the Board meeting today to make considerable progress, but not to reach such a high level of agreement. The only firm deadline the committee faces is to allow the G-20 heads of government to have a detailed set of rules that they can endorse in November at the Seoul G-20 summit. It now appears that they will have no serious difficulty with that timing, unless something happens to cause their preliminary agreement to fall apart. (One country apparently reserved the right to object, pending further details that will be released by September. However, this seems unlikely to prevent a consensus from being reached in the end.)

The good news goes beyond the high probability of meeting their deadline. The Committee appears to have preserved the integrity of their original set of proposals, laid out in a consultative document in December of last year. There has been considerable "horse trading", but the results appear sound. The two biggest modifications seem reasonable, although not precisely what I would have done. The "Net Stable Funding Ratio" test is effectively being pushed off for eight years while regulators focus on developing a truly workable version. This is one of two new tests to ensure that banks have the liquidity they need in a financial crisis. Unfortunately, it was problematic from the start and was the target of much legitimate criticism from the financial industry. There is the possibility that it would have significantly raised the cost of lending and thereby had a negative impact on the economy without an equivalent increase in safety. Luckily, the other liquidity test, the so-called "liquidity stress test", appears to work much more smoothly and its framework has been left intact, albeit with a number of technical revisions that make it less onerous.

In addition, the leverage test, which is a test of capital adequacy that treats all assets as equally risky, has also been pushed out eight years. There will effectively be a long period in which it will be calculated, and eventually disclosed, but will not be a binding global requirement. Although there were many technical problems in making the leverage test work optimally, I would prefer to have seen it become binding sooner. Nonetheless, its eventual adoption still appears likely, which is good. (U.S. banks already face a leverage test and therefore were never likely to be much affected by the change. European and Japanese banks would have been much more affected.)

There were a host of other technical changes which will have real significance in aggregate. Fortunately, they appear broadly sensible and do not seem to undermine the intent of making the capital and liquidity requirements substantially more stringent.

Overall, therefore, the news is good on both timing and on the maintenance of the basic integrity of a globally negotiated, harmonized increase in capital and liquidity requirements. This should be good for all of us, as the increased safety should considerably outweigh the costs.

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