Over in the great business and trade world of Minyanville, I have a new article breaking down the Basel III capital adequacy standards that were released this past weekend. The Basel standards set minimums and guidelines for how banks on a global scale should manage their risk, specifically for how much capital they hold in reserve in case of a problem. The new rules are necessary because the old rules failed. Ironically, the answer for regulators was to let the same people who failed with the first two set of rules design another one—on the same basic principles.
To me, this is like letting John Travolta direct another Battlefield Earth movie. Still, there's something to be said for trying to keep investors and consumers safe from the falling concrete of a crumbling bank.
But, as I write in the piece, "while the overall new design for capital requirements is well-intended, and might be more prudent than previous iterations of international banking standards, the Basel III Accord misses the main lesson of the global financial crisis: Over reliance on regulatory structures decreases incentives for financial institutions to watch their own backs."
I see three basic problems with the new rules:
- First, the new system is overly dependent on the all-knowing wisdom of regulators.
- Second, the rules are blunt and arbitrary. How do we know that 4.5% is high enough? Or that a 2.5% buffer will hold up in financial storm?
- Finally, the complexity of the rules doesn’t make sense. Basel II had a “three pillars” approach, but Basel III is broken down into “four layers” of capital requirements.
So what should we do in stead?
Banks should be able to set their own capital requirements, but if the government is going to do it for them, then a single, simple, significant reserve level would avoid depending on regulators to time the market and help investors more easily understand the safety and soundness of banking institutions.
It wouldn’t be a perfect system. It would stumble into the same trap of arbitrary standards. And it would need to take into account the different types of banking institutions in the market to be less blunt than Basel III. But hopefully it would bring more objectivity and certainty to the marketplace.
In an ideal world we wouldn’t need to have these, well, dumb rules. But since this and other criticism is unlikely to change the Basel rules in the near future, the market will need to prepare for the next crisis. To put our faith in the regulatory designs of the same men who failed to detect or prevent the financial crisis is silly enough. But to believe that bankers won't find their ways around the new laws or manipulate them for gain while putting the taxpayers at risk, is cognitive dissonance at best.
To read more of my analysis of the Basel accord, and details on why those three problems cripple the new rules, check the full piece in Minyanville here.