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This is Basel III??

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Arriving at the rush, with extra impetus doubtless imparted by the recent and ongoing Eurobanking panic, we have the Basel III capital and liquidity reforms (there’s a one pager, a full press release and, oh, not wholly unexpectedly, a somewhat anticlimactic phase-in timetable). In fact, the liquidity reforms here are just timetable entries – the relatively demanding funding ratio proposals from December last year got shunted into a siding, back in July.

So, errm, for the moment, what we have are just some capital ratios, actually. Enough to get DB moving: they are raising another EUR10Bn, at the front of the queue. So I suppose the Germans are once again first to put their beach towels on the prime sunbathing spots.

If you are terribly enthusiastic about the detail of Basel III bank regulation, I suppose I should add that the other bits and pieces of regulatory apparatus will be the December stuff, plus changes as summarized by Deus Ex Macchiato, or officially, here.

But why be all that enthusiastic about Basel III? It’s still the mixed bag I wrote up here. I see that the end-2012 implementation “with appropriate transition and grandfathering arrangements” now translates to something that won’t be fully elaborated until 2020. All together: quelle surprise!

So what do we think about the capital requirements? Relative to the insane 2% common equity cushion endorsed by Basel II, the new 4.5% requirement, with another 2.5% to be phased in by 2019 (not much sense of urgency there) looks much better. There’s a limit to what any capital requirement could do, of course.

Here are my main gripes:

Valuation: the capital ratios mean nothing if the assets are overvalued. Waldman is always going on about this. It ends up as quite a radical critique: capital ratios without valuation reform = cart before horse.

Accounting: there is still no harmonization of accounting practices on all the shadow banking apparatus: for instance, special purpose vehicles, derivative netting and repos. Actually, of course, when you come across things like Repo 105, or BoA’s quarter end balance sheet manipulations, there don’t seem to be any relevant reputable accounting practices at all; even if you think Lehman’s liquidity pool probably is an outlier, some of this stuff really, really needs fixing. And do we think that under Basel III there will be more accounting dodges that will cross the line from ‘asset sweating’ to ‘accounting manipulation’?  Not Basel III’s fault, but I rather think we do expect exactly that.

Regulatory risk weightings are still a mess, with the ratings agencies still ensconced as the arbiters of credit quality.

Then of course there is shadow banking, which Basel III largely dances around. One particularly glaring example is the whole custody/client money/asset segregation/rehypothecation/title mess in London. There’s not a peep, burble or whisper here in the UK about the sort of legal reforms (somewhat in the manner of the US’s 1934 Securities Act, perhaps, plus a UK version of SIPC) that would sort this out. Recent Lehman-related rulings on Client Money actually mess the situation up even more. Of course, our obligingly vague 17th century line on “who owns what” works very capital-efficiently for Prime Brokerages. Which is a big part of why Mayfair now houses a $4Trillion shadow banking system. Push from Basel III would have helped get more of a grip.

I have nothing to say about enforcement; it’s been such a long time since I’ve seen any that I’ve forgotten what it is.

In the end, these and other regulatory arbs are all consequences of politics. Pending some unimaginable transformation there, in which regulators somehow acquire the discretion to pick fights with banks, Lex (with apologies for his English usage) tells it how it is :

the reality is that a Basel III world will not look hugely different to  the one from which the last crisis sprang.

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15 comments

  1. killben

    Regulators are Politicians who wear a different suit. They act the same.. protect their masters .. their only purpose!!

  2. Opinionated Bloviator

    To little far to late, perhaps pogroms are needed to motivate the eurocrats to get serious about fixing the broken regulatory system that is shanking everyone who is not To Big To Fail or who does God’s work. If not there’s always total economic collapse. My money (and the relentless increases in the price of Gold) is on the latter.
    To Big To Fail violates fundamental universal laws, it WILL end, only the timing is not known.

  3. vlade

    Yves, on the rehypo – didn’t see your article before, so comment here. I’m susprised you didn’t pick (much more than you did) on the other damage it does – basically, for you as the client it means getting f*cked up by the broker – IIRC even if you had no short positions/margin loans at all, but just had the ability to do so (and margin often gets included automatically). As it means mixing client/firm assets, you can lose everything, including the cash you had at the firm. That is not just hedgies, but small retail guys, in fact it’s worse for them because they are less likely to deal with a TBTF broker who might get saved.

    John Hempton had a few posts on this earlier this year – it works like that in Oz as well and John was predicting brokers there going belly up with clients losing money. And his prediction was pretty on the money.

    1. Richard Smith

      These days UK retail clients who want to do margin trading tend to go to the likes of IG Index – a specialist betting shop (and hence tax-free). They are still subject to FSA regulation (for what that’s worth) but in the end I doubt whether there’s the same level of concern about protections for self-described gambler as there is for um, self-described investors.

      There are or were some UK retail brokers that did margin trading (e.g. via CFDs) but it was very much a minority sport. They would have found it difficult to match the level of investment that the betting shops have put into their ‘trading platforms’.

    2. Yves Smith

      We have thumped on it occasionally, and also noted that a recent BIS paper put rehypothecation as being much bigger than suspected, hence pumping up the size of the shadow banking system to a bigger size than previously estimated.

      The reason we haven’t made more noise about it is it is hard to get readers excited about an abuse that affects mainly prime brokerage customers, meaning hedgies. For regular folks, that strikes them as a “caveat emptor” issue, even though this practice is by any common sense standards a big time abuse.

      http://www.nakedcapitalism.com/2010/08/how-misuse-of-client-assets-pumped-up-shadow-banking-system.html

      http://www.nakedcapitalism.com/2008/10/how-lehman-blew-up-city-of-london.html

      http://www.nakedcapitalism.com/2008/09/hedge-fund-customer-assets-stuck-for.html

      http://www.nakedcapitalism.com/2008/02/hedge-funds-questioning-soundness-of.html

      Note date of oldest entry…prior to Bear meltdown.

    3. Richard Smith

      In a closely related area, securities lending, (flip side of margin trading if you like), there are definitely issues that can affect UK investors very directly – via their pension funds and collective investments. Something bang up to date from Alphaville here: http://tinyurl.com/2vkbymn

  4. fuzed

    I’m thinking that for the phoenix to rise again, it has to wholly burn down, that it can’t get new life by burning a few old feathers.

    Is that too obtuse?

  5. Deus-DJ

    Thanks for posting this Richard.

    fuzed: I’m not certain that obtuse is the right word, but “dim” certainly is. What you say isn’t necessarily true; there are far too many factors involved to be making such statements. I just don’t think the right set of people are around to blast these guys for being incompetent and/or putting themselves far too deep into the pockets of the banks and others. One thing you have to remember is that we as a people like to think within the same sphere as our group…if most generally the peers around you are worried about keeping “competitiveness” up and nobody talks about slamming the banks then those making the rules will just go with what they personally think is responsible.

    The fact is that we just aren’t being loud enough…we need someone out there with a moral righteousness to blast these mother fuckers for being idiots.

  6. Hugh

    Good critique. We can tell how serious Basel III is by the fact that the stock market went up in response to it. The markets know that as far as Basel III is concerned the casino is still open.

  7. surfwalker

    The one thing the eurofascists learned from the Big One is that major changes can’t be implemented at a stroke. Hence the present baby steps. They know that they’re going to be subsidizing most of the economies of Europe for quite some time. The goal here is not to restore financial accountability among Member States but to maneuver them into a corner so that they can be stripped of their remaining sovereignty.

  8. marc fleury

    glad you are covering this.

    The increase of capital ratios do make the banking system more resilient. I do also believe that they side step the whole shadow banking thing. It also makes sense. Basel is a bunch of banks and bank regulators, they do not want to address the bigger monetary issue of debt levels. Until the debt levels are regulated we will run in minsky bubbles.

    This strengthens the banking system in the event of a crisis, it does nothing to address the crisis though.

    I blog briefly about this here: http://www.thedelphicfuture.org/2010/09/basel-iii-is-out-who-cares.html

  9. Per Kurowski

    It is impossible not to see now that the financial regulators in the Basel Committee, trying to fend off a bank and a financial crisis, constructed an incredibly faulty Maginot Line.

    It was built with lousy materials, like arbitrary risk-weights and humanly fallible credit rating opinions.

    And it was built on the absolutely wrong frontier, for two reasons:

    First, it was build where the risk are perceived high, and where therefore no bank or financial crisis has ever occurred, because all those who make a living there, precisely because they are risky, can never grow into a systemic risk. Is being perceived as risky not more than a sufficient risk-weight?

    Second it was built where it fends of precisely those clients whose financial needs we most expect our banks to attend, namely those of small businesses and entrepreneurs, those who could provide us our next generation of decent jobs and who have no alternative access to capital markets.

    Now with their Basel III the Basel Committee insists on rebuilding with the same faulty materials on the same wrong place and it would seem that we are allowing them to do so.

    I am trying to stop them… are you going to help me or do you prefer to swim in the tranquil waters of automatic solidarity with those who are supposed to know better?

    The implicit stupidity of the Basel regulations could, seeing the damage these are provoking, represent an economic crime against humanity!

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