http://www.businessweek.com/articles/2012-11-15/bloomberg-view-basel-iiis-bedeviling-complexity

Bloomberg View

Bloomberg View: Basel III's Bedeviling Complexity


The European Central Bank's new headquarters, still under construction, right, stands beyond a rail bridge spanning the River Main in Frankfurt

Photograph by Simon Dawson/Bloomberg

The European Central Bank's new headquarters, still under construction, right, stands beyond a rail bridge spanning the River Main in Frankfurt

More than four years after a financial breakdown plunged the world economy into the worst slump since the Great Depression, efforts to build a stronger global system of bank regulation are barely inching forward. Regulators seem overwhelmed by the complexity of their own reforms. To make faster progress toward a safer system, governments must aim for greater simplicity.

The Federal Reserve and other regulators have said U.S. financial institutions won’t be held to a Jan. 1 deadline to boost their capital as required by the Basel III international banking standards. At the end of October, the chairman of the Financial Stability Board—the multinational panel overseeing the Basel III reforms—said he expected that only 6 of the 28 global banks identified by the board as “systemically important” would be covered by the new rules on the agreed start date.

As Andy Haldane of the Bank of England recently explained, the problem lies in legislating national rules that conform to the new Basel standards. That’s difficult because the standards are complicated. The Basel I agreement of 1988 was 30 pages long; Basel II in 2004 logged in at 347; Basel III is 616.

Basel III is a model of brevity compared with the Dodd-Frank law that codifies the broader U.S. regulatory response to the crisis. Haldane has estimated that the rulemaking could ultimately amount to 30,000 pages. Many of those pages are the result of banks’ own efforts to insert exceptions and caveats.

The financial crisis belies the idea that increasingly complex rules are the right way to control an increasingly complex system. Simple is best, especially when it comes to the core of the new standards: capital adequacy. A capital ratio, at its essence, should be the amount of money that a bank’s shareholders put at risk as a percentage of the bank’s assets. Basel III complicates the calculation by allowing banks to place a lower weight on supposedly safe assets and by adding other obligations, such as hybrid bonds, to the definition of capital.

Basel III does introduce a simple ratio of equity to assets, but sets the adequacy level at just 3 percent. In other words, a mere 3 percent decline in the value of a bank’s assets—far less severe than what happened in the recent crisis—would be enough to render it insolvent. Worse, the ratio is proposed merely as a supplementary monitoring tool, not the binding regulatory limit it should be.

Finance experts have advocated, and Bloomberg View supports, a simple equity-ratio requirement of as much as 20 percent of assets. Research by various economists, including Anat Admati of Stanford University and David Miles of the Bank of England, suggests such sharply higher capital requirements would produce a net benefit for the economy. To be sure, regulators will still have to take the nature of assets into account: If a bank specializes in high-risk real estate lending, for example, even 20 percent might be too little. A balance must be struck, but it’s increasingly clear that regulators have erred too far in the direction of complexity.

To read Stephen L. Carter on Obama and FDR and William Pesek on the president’s trip to Asia, go to: Bloomberg.com/view.


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