Basel III – a sensible bedrock
Guest contribution published in the Börsen-Zeitung on 29.12.2017
Many German banks are still railing against the final version of Basel III – the global minimum regulatory standard for banks which was wrapped up just under a month ago. Basel III, they say, will only create costs, which will stretch them to the limits. Some have even raised the spectre of a credit crunch.
At first glance, these misgivings would seem quite understandable. No one would deny that tighter new rules take time and money to implement, besides curbing certain types of risky business. But stakeholders who confine the debate to just the cost of regulation risk losing sight of an entirely different set of crucial developments. One major issue going forward is that banks and savings banks will have to face up to a whole new world – a more competitive and increasingly digitalised financial landscape, coupled today with rock-bottom interest rates. Viewed from this angle, might it not be just as fair to regard Basel III not just as a burden but also as a sound bedrock underpinning banks’ stability?
The Basel III package as a whole is a well-designed and balanced standard – a forward-looking regime which challenges, yes, but never overwhelms. It’s hugely important to be aware that we have now put a global minimum standard in place which will place banks in Europe pretty much on a level playing field with their US counterparts. The recently finalised set of reforms will do much to boost financial stability, by curtailing the discretionary scope for measuring the risks that need to be backed with capital. While the recent agreement to limit the benefits banks can derive from using internal models by setting the output floor at 72.5 %, at least, is hardly the outcome Germany had been hoping for, now, at least, global systemically important institutions will be asked to back their risks with as much capital as their exposures warrant, though their requirements will admittedly be a little higher. Requirements will remain largely unchanged for small and medium-sized banks, and there will even be capital savings for many of Germany’s small institutions.
One particular point I would like to stress is that the fear of collateral damage to the economy is, by and large, unsubstantiated. Germany isn’t going to suffer a credit crunch. Those concerns were already being voiced back when the initial phase of the Basel III reforms was wrapped up in 2010 – yet they never materialised. And that phase revolved around raising a colossal €277 billion of additional capital for Europe’s undercapitalised banks, compared with a figure of €17.5 billion today. Not just that: credit institutions will be granted a ten-year phase-in period to build up capital. Supervisors now have the task of arranging the transition in a way that enables credit institutions to calmly adjust to the new regime.
So Basel III is on its way, and I for one am glad that it is. The main question now is how it will be implemented, because there is little point in having a set of Basel standards if their transposition into national law is watered down or served à la carte. That was particularly what happened in the case of Basel II, which was not fully implemented in either the United States or the EU. One reason why the finalisation of Basel III is now placing disproportionate demands on Europe’s credit institutions boils down to the half-hearted way in which the EU implemented the Basel I floor, which essentially predates today’s output floor.
Set at 80 %, that floor was always used as a prudential measure, but if its implementation back then had been true to the Basel Committee’s intentions, it would have sent risk-weighted assets higher and capital ratios lower. The 72.5 % floor isn't all that new, then – and compared with the Basel I floor, it's actually lower.
Stakeholders should now expect Basel III to be transposed, in full and as quickly as possible, into European law, not least as a way to establish legal certainty for credit institutions. The superior risk measurement methods and the constraints placed on the use of models will boost the firepower of the Single Supervisory Mechanism, one of the pillars of Europe’s banking union. With elections to the European Parliament scheduled for mid-2019 and the subsequent appointment of a new college of Commissioners, I’m somewhat sceptical about the time schedule, though. Implementing Basel III quickly won't be an easy task, which is precisely why we can expect to see European policymakers get the ball rolling before 2018 is out so that we won’t be starting from scratch at the end of 2019.
Rethinking banking business
Quite apart from the institutional and regulatory framework, there is also the matter, going forward, of rethinking “banking business” itself. Banks and savings banks are operating today as service providers in a digitalised financial landscape that is posing a growing threat to traditional business models.
For financial institutions, a great deal is at stake; for some, their very survival is in the balance. Digitalisation is making it possible to run even the most complex bank operations using algorithms. Fintech competitors are often more efficient and more innovative. So how exactly do credit institutions fit into this set-up?
Questions like these can easily blind the sceptics among us to the unprecedented potential which the digital world of finance is opening up for banks and savings banks to rejuvenate and refresh their operations. Twenty years into the future, the strongest institutions will be the ones which are already reinventing themselves today.
What they need to do now, then, is to incorporate compelling solutions into their future business models if they do not want to lose ground to innovative rivals from outside the financial sector. Bearing all this mind, I firmly believe that Basel III will constitute a sensible bedrock for innovative business models and the stability of banks.