Parking Basel: A Case Study of How Banks Stymie Regulatory Reform

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By Richard Smith

Back in September 2010, Tim Geithner gave this testimony to the House Financial Services Committee, about the newly-agreed Basel III capital requirements:

Last week the Federal Reserve, the OCC, and the FDIC reached agreement with their principal foreign counterparts to substantially increase the levels of capital that major banks will be required to hold.   As a result of this agreement, banks will have to hold substantially more capital.  The new standards are designed to ensure that major banks hold enough capital to withstand losses as large as what we saw in the depths of this recession and still have the ability to operate without turning to the taxpayer for extraordinary help.

This agreement will make our financial system more stable and more resilient. By forcing financial institutions to hold more capital, we will both constrain excessive risk-taking and strengthen banks’ abilities to absorb losses.  This agreement is designed to allow banks to meet these more stringent standards gradually over time, so that they can continue to perform their essential function of providing credit to households and businesses.

These standards will help establish a more level playing field around the world. By moving quickly to recapitalize our financial system, we have been in a strong position to insist on tough standards abroad.

Well, that’s all looking pretty empty now:

Federal banking regulators on Friday took a step back from efforts to meet the international standards and capital rules promoted by the international Basel Committee on Banking Supervision (Basel III), delaying new rules that were set to begin at the start of the year. No alternative timeline was suggested.

“Many industry participants have expressed concern that they may be subject to a final regulatory capital rule on Jan. 1 without sufficient time to understand the rule or to make necessary systems changes,” a joint statement by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency said. “In light of the volume of comments received and the wide range of views expressed during the comment period, the agencies do not expect that any of the proposed rules would become effective [by the effective date].”

So when will the Basel III rules become effective in the US, then? If the grim views of Thomas Hoenig, vice chair of the Federal Deposit Insurance Corporation, have any weight, which they probably do, the most likely answer is never:

“Given the questionable performance of past Basel capital standards and the complexities introduced in Basel III, the supervisory authorities need to rethink how capital standards are set,” Hoenig, former president of the Federal Reserve Bank of Kansas City, said during a recent speech. “Starting over is difficult when so much has been committed to the current proposal. The FDIC is no different from other U.S. and international regulatory agencies where committed staff has devoted enormous effort to drafting and implementing Basel III. However, starting over offers the best opportunity to produce a better outcome”

This delay (or cancellation) in turn undermines the already uninspiring Dodd-Frank Act in the US, which relied on Basel III for the capital rules covering large US banks.

Now, this blog is no fan of the post-crisis reregulation we’ve seen so far, neither Basel III nor Dodd-Frank. So if Basel III is on the way to the scrapheap, what’s not to like?

Ah, if only one believed that the reason Basel III was on the way out because of its incoherence as a regulatory framework. In fact, its so far part-completed demise is a classic case of the lobby in action. Here’s how the anti Basel lobby did its stuff.

Scene 1. Six months after Geithner’s fanfare, quoted above, a certain American banker, mouthier, in the days before the London Whale, than he is just now, starts a softening bombardment, in April 2011:

Speaking to the Council of Institutional Investors, Dimon delivered his harshest assessment yet of Basel III, arguing that regulators are “getting extreme and excessive.”

“I can’t prove this right now, but for all the academics here, it will stifle economic growth,” Dimon said. “I believe it already is. I believe banks around the world are deleveraging and preparing for the potential impact of Basel III … charges right now.”

Passionate convictions trump evidence every time, of course.

Scene 2. Next, Jamie changes tack, and increases the volume: American banks specifically are being picked on, and the US should withdraw from the Basel accords.

“I’m very close to thinking the United States shouldn’t be in Basel any more. I would not have agreed to rules that are blatantly anti-American,” Dimon told the FT. “Our regulators should go there and say: ‘If it’s not in the interests of the United States, we’re not doing it’.”

So much for the level playing field, eh?

Scene 3. More recent practical objections consolidate the American position. Well, the systems guys can’t figure the spec out, and no wonder – it is a matter of piling obscure, but certainly complex new rules, on top of existing obscure but complex systems, supporting existing complex businesses. Plus there are revenue/cost pressures, as ever; non-one wants to spend the money.

The official US cancellation announcement follows hard on the heels of this last news item.

Next the Euro side of the lobby gets to work. We have the usual types of responses to the news from America:

Scene 4. A quick snarl by a French official

Scene 5. Complaints, by non-US banks this time, about the “loss of trust” resulting from the US Basel III postponement (you can read that as suspicion that somehow, the Americans are tilting the paying field in their favour):

Delaying the introduction of the new Basel III banking regulations in the United States is hurting trans-Atlantic relations, Deutsche Bank co-chief executive Juergen Fitschen said on Thursday. “We can only call on all parties to return to the table as quickly as possible to restore trust,” he said at an event late on Thursday.

The comments come after U.S. banking regulators said earlier this month they did not expect the Basel III rules, designed to make the global banking system more resilient in the aftermath of the financial crisis, to take effect on January 1.

“And when the whole thing is called un-American, I can only say in disbelief, who can still believe in this day and age that there can be purely European or American rules,” he said, referring to comments JPMorgan CEO Jamie Dimon made in a Financial Times interview two months ago.

That’s a telling fingerpoint, by Deutsche Bank, at Jamie Dimon. Deutsche were of course watching his moves all the time, waiting for their turn on the ratchet. So the Eurobanks can now fish for an opportunity to adjust the regs in their favour. Perhaps Jamie will demand another concession after that; or some other banker gets his turn at the megaphone.

Whatever; the thin end of the wedge is now inserted. The playbook from here is to repeat kabuki scenes 1-5 from whichever side of the Atlantic has the next turn, until everyone’s happy and the regulations are suitably diluted, exempted, compromised, watered down, and generally fit for no-one’s purpose, except for bankers’.

In the US, the end game is obvious: no meaningful adoption of any Basel III rules. That’s not at all a hard read-across – Basel II is also not yet adopted in the US. You can read the story here, if you like that sort of thing. The lobby got to work back then too. Small US banks protested that they would be put at a competitive disadvantage vis a vis large banks, if large banks were made to use the Advanced risk models available in Basel II. For contrast, large US banks protested that, if forced to adopt the Advanced risk models, they would be put at, did you guess, a competitive disadvantage vis a vis small banks. So the regulators split the difference, and the small banks stayed as they were. And, so far, so did the large banks. Neat.

Result: five years after Basel II’s official adoption in the US, it’s still parked. Evidently Basel III will line up alongside, soon enough. Let’s see how it goes with Dodd-Frank next, shall we?

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  1. vlade

    – EU is not implementing it’s CRD4 on time (Jan 2013) either. At the moment the only regulator of note that still didn’t say “we will delay” is Australian, and reason for that might be that they are too excited by rugby to care.

    – B3 has a lots of holes in it, as in really badly thought out ideas and is half cooked at best. In fact, it’s bad just because it keeps going the “we need more detailed regulation than before” route instead making regulation simple and tough (and remove the whole rating agencies reliance from it in the first place…).

  2. craazyman

    when it’s over so they say
    It’ll rain a sunny day
    they know
    Shinin’ down like water . . .

    -CCR (sort of)

    yeah, uh huh

    1. JEHR

      And so we, the audience, have a front row seat watching the way the financial system works its “magic.”

  3. renholder

    This is off-base. Basel II was never adopted because it would have resulted in a significant reduction in capital at the largest banks. By the time the implementation date was due, the crisis was in full force. Does it make sense to implement Basel II?? No.

    One of the main reasons for the delay in Basel III is that Basel III required credit ratings – Dodd-Frank made that impossible. So the regulators had to come up with an alternative, which took a long time. The NPR was supposed to be out in January 2012 to give enough time. But, the NPR only came out in June. So we are a little delayed, but the NPR coming out means that the agencies are in consensus. This is by far the biggest hurdle. Also I expect if Romney was elected, this would be a bigger problem, but he wasn’t so it’s status quo. Yes Jamie Dimon was vocal in delaying Basel III, but I think after the trading loss he lost a lot of support. Same with MF Global.

    Of course, Hoenig, Haldane are saying that basel III is a step in the wrong direction. Probably the risk weighting and advanced approaches are; but the capital rules are significant improvements over Basel I and II. Addtionally, a global leverage rule is not a bad thing either. I don’t think it will prevent the next crisis, but it will make it so that banks hold more and better capital in the next crisis.

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