Basel: Global bank supervisors are not a fast-moving bunch: The last set of capital rules took a decade to design and implement. So it is to the regulators' credit that new rules, known as Basel III, were agreed just two years after Lehman Brothers collapsed.
The Basel Committee has 27 members, so any agreement was bound to involve a compromise. The first bit of horse-trading was over the amount of equity capital that banks are required to hold. Though the ratio has more than doubled, from two per cent of a bank's risk-adjusted assets to 4.5 per cent, hard-liners would have liked even more.
Regulators have also introduced a 2.5 per cent "capital conservation buffer". In theory, banks can draw on this buffer in hard times. In practice, none will want to. So the actual minimum equity capital ratio – formerly known as core Tier I – is now seven per cent. This is a big improvement: Royal Bank of Scotland went into the crisis with a ratio of just four per cent.
The other compromise is over timing. Japan and Germany were worried that their banks would be at a disadvantage. So the rules will be phased in. The capital conservation buffer doesn't have to be in place until January 2019. Unlisted German banks have been given until 2023 to fully replace their "silent participations" - debt-like instruments that previously counted as core capital. But investors are unlikely to pay much attention to this timetable. Any large lender that depends on the support of the markets will be expected to show that it meets the new standards today. And banks will want to hold an additional bit of capital in reserve. That is why most already have equity capital ratios above eight per cent. One of the few that doesn't – Deutsche Bank – unveiled a ¤9.8 billion rights issue just hours before the Basel agreement was announced.
Moreover, regulators are not finished. National authorities have the right to demand that banks hold up to 2.5 per cent of additional capital, depending on the economic cycle. Large, systemic banks will probably have to hold an extra buffer.
Even if regulators can ensure the new rules are implemented around the globe, higher capital ratios alone will not prevent another crisis. Regulators must also enforce recently-agreed tougher liquidity standards, and introduce laws that allow even big banks to be wound down if they get into trouble. The new rules could also just shift risk to other parts of the financial system, like hedge funds or insurance companies. Even so, the Basel III agreement is a good start.
