LONDON – The financial crisis of 2008 gave a big boost to the global standard-setters. Suddenly, the Basel Committee (which sets the standards for international banking supervision) was leading the financial news. Dinner parties in Manhattan and Kensington were consumed with the finer points of Basel II and the evils of procyclical capital requirements. Governments that had been suspicious of international interference were eager for tougher global rules to prevent banking crises from spilling across borders and infecting others, like bouts of Asian flu.
The concrete consequences of this enthusiasm were the creation of the Financial Stability Board (FSB), born out of the ashes of the Financial Stability Forum, at the G20’s London summit in April 2009, and inclusion of representatives of all G20 members among the key rule makers in Basel and elsewhere. The G7’s domination gave way to the hope that broader membership would produce more comprehensive buy-in and stronger political support for increasing the banking system’s capital.
All this change has worked, up to a point. The Basel III regulations, for example, more than doubled the capital an individual bank should hold, and enhanced the quality of that capital. The system looks somewhat safer as a result. But now there are dangerous signs that the commitment to stronger global standards – indeed, to any common standards – may be on the wane.
Many predicted this trend, but for the wrong reason. Skeptics warned that it would be far harder to reach agreement among 20 or more countries than it had been among the dozen pre-crisis Basel Committee members (mainly European countries, with only the US, Canada, and Japan representing the world beyond). In practice, that has not turned out to be a major problem. Basel III was agreed far more quickly than Basel II was. Political pressure from finance ministers, expressed through the FSB, proved effective.
In fact, recent tensions have been more old-fashioned, pitting the US against the eurozone, with the UK and others stuck in between. The US has been pressing for tighter controls on banks’ internal models, and for a limit on how much a bank’s models can reduce its assets on a risk-weighted basis. Agreement on these so-called output floors has so far proved impossible. The Europeans argue that their banks’ corporate lending is inherently less risky. After all, EU banks lend more to higher-rated large companies, which access US capital markets, rather than borrowing from banks. They also hold more low-risk mortgages on their balance sheets, in the absence of a European equivalent of Fannie Mae and Freddie Mac (America’s two quasi-public mortgage banks), which hoovered up securitized US mortgages.
At its meeting in Santiago, Chile, in November, the Basel Committee conspicuously failed to agree on a solution, and kicked the issue upstairs to the committee of Governors and Heads of Supervision, which will try again in January.
They will probably find a way to thread this particular needle. But the future for global standards looks more uncertain than it has for some time. Since the 2008 crisis, many countries, while ostensibly supporting the development of tighter global rules, have been taking other measures to protect their own financial systems.
The collapse of Lehman Brothers and others showed, in former Bank of England Governor Mervyn King’s memorable phrase, that big banks are “global in life, but national in death.” In other words, when a global bank crashes, the host-country regulators must pick up the local pieces. That’s why requirements to establish local subsidiaries, with local capital, have been adopted. Gone are the days when banks could set up branches all over the planet, with support from the parent’s balance sheet. Subsidiarization is now the rule.
And, looking ahead, we can see that the two biggest players in the FSB and Basel have other preoccupations. Donald Trump’s incoming US administration has already signaled its suspicion of foreign entanglements and international commitments. Making America great again is not likely to involve new enthusiasm for more intrusive rules made in Basel. Those who advocate rolling back much of the 2010 Dodd-Frank financial-reform legislation, in favor of a higher leverage ratio, as promoted in a bill advanced by Representative Jeb Hensarling, envisage a “Made in the USA” version of banking regulation. But, while the idea has some merit, it would not sit easily within the current Basel framework.
Europe faces other worries. Regulators there are now keenly focused on the implications of Brexit, which will require complex arrangements to manage a new relationship between London and the eurozone. The top priority for the European Central Bank must be to preserve the integrity of the EU banking union, which is under pressure from both Brexit and the crisis gripping Italy’s banks.
Against this background, it will be a challenge to retain the primacy of global standards and to secure continued buy-in to the Basel process. The Bank for International Settlements’ new general manager, Agustín Carstens, a former governor of Mexico’s central bank, will have a key role to play, as will whoever replaces Mark Carney (the current Governor of the Bank of England) next year as Chairman of the FSB. It is likely, too, that there will soon be a new Chair of the Basel Committee itself. Stefan Ingves of Sweden is due to step down next June.
These three new leaders will need all of their diplomatic skills to navigate treacherous political waters. The stakes are high. If the commitment to global standards wanes, everyone will suffer in the long run. Countries will impose incompatible local requirements, which will reduce the efficiency of capital utilization and make the system less robust in the event of renewed financial instability.
The writer is the first chairman of the United Kingdom’s Financial Services Authority (1997-2003).
Copyright: Project Syndicate