FRANKFURT — A decade after the global financial meltdown, banking regulators from the world’s biggest economies on Thursday announced the final deal on capital rules that they hope will make banks safer.
Or at least less likely to unleash huge economic shock waves when they collapse.
The Basel Committee on Banking Supervision’s oversight board — the Group of Governors and Heads of Supervision, known as the GHOS — gave its green light to the new framework after a meeting in Frankfurt.
“It’s a great day,” said a beaming Mario Draghi, president of the European Central Bank who also heads the GHOS. “Today’s endorsement of the Basel III reforms represents a major milestone that … completes the global reform of the regulatory framework, which began following the onset of the financial crisis.”
Now, it is up to Basel Committee members — central banks and banking regulators from the world’s largest economies — to incorporate the standards into national law.
This was long in the making.
A deal on the so-called Basel III standards was initially targeted for the end of 2016, but global regulators were unable to agree on how to determine banks’ capital requirements, or the money they should have with their own un-borrowed funds to cover all kinds of risks.
The biggest — and so potentially the most systemically important — banks currently use their own internal models to calculate the minimum amount of capital they need to always hold. But the Basel Committee argued that internal models can be too easily gamed, as was the case when banks came up with too-low capital requirements in the run-up to the financial crisis. Regulators found that two banks with very similar lending portfolios could have wildly different capital requirements, with no obvious reason for the distinction.
The Basel Committee therefore introduced proposals for calculating capital requirements based on a standard, regulator-set methodology commonly referred to as the “output floor.” This refers to the threshold below which a bank’s capital requirements cannot go when calculated using its own internal model.
The wrestling match over capital requirements pitted principally EU against U.S. regulators.
The Americans argued for more stringent requirements. The Europeans claimed American banks would not be hit as hard by any potential floor as their businesses are less reliant on bank loans and more on capital markets. In addition, European banks keep potentially risky mortgages on their balance sheets, while U.S. banks offload them to government agencies.
EU regulators echoed European banks’ arguments that a high output floor would force them to hold too much capital, resulting in increased costs for them and ultimately for their corporate and retail borrowers. And if that squeezes the amount of capital available in the system, they argued that economic growth would suffer.
Some regulators were also concerned that the reduced reliance on internal models would do away with “risk sensitivity” — in other words, using a regulator-set, standardized approach may not sufficiently take into account the likelihood of a customer defaulting and prompt institutions to lend to more risky clients.
Speaking at the end of November, Andreas Dombret, an executive board member of Germany’s Bundesbank, said the floor was too high and would “diminish” risk sensitivity. But he hinted Germany was willing to support the compromise anyway, a sign of the EU backing down from previous positions.
With the constant back-and-forth between EU and U.S. representatives and the repeated failure to get an agreement, there were growing doubts whether the Basel Committee would ever reach one. Talks were also held up by the election of U.S. President Donald Trump and the months it took for Randal Quarles to take up his position as the Federal Reserve’s vice chair of supervision, which left the U.S. without a negotiator.
But the output floor remained the thorniest issue. The EU stood firm on its desire for a 70 percent floor, while the U.S. pushed for a 75 percent floor.
Ultimately, they met half way — at 72.5 percent. The floor will be phased in over five years, starting in 2022.
“We should understand this is a compromise,” said Draghi. “There were members who wanted higher level, members who wanted lower.”
But this now leaves European banks to frantically calculate exactly what the final deal will mean for their businesses.
According to an impact study carried out by the European Banking Authority, the most systemically important banks in the EU would see their capital requirements rise on average by 15 percent. For the entire EU sample used in the study, which comprised 88 European institutions, the average minimum required capital would increase by 12.9 percent.
Speaking to reporters in Brussels, Valdis Dombrovskis, the European Commission vice president for financial services, said “we’ll need to consider the specificities of the European economy in terms of the banking sector and its role in financing the economy.”
Banks generally welcomed the final deal, despite their earlier pushback. Mark Gheerbrant, head of risk and capital at the International Swaps and Derivatives Association, said it provided “much-needed certainty for the industry.”
With global standards now set, work has only just begun for national regulators. Basel rules are not legally binding, and have to be writen into national laws. For the EU, this will mean a new legislative proposal, plus the usual scrutiny from the European Parliament and Council.
Ultimately, not everything that has been decided at the Basel level may trickle down into EU law. If European banks find that today’s agreement doesn’t work for them, the huge lobbying push will begin again — and may be more successful, given that they have the sympathy of many EU officials in Brussels and national ones in European capitals.
And new rules certainly don’t mean there won’t be any new banking crises.
“Nothing is crisis-proof,” said Draghi, but “[we can] clearly see the present system is much more resilient than the one we had before the crisis.”
His sentiments were echoed by Stefan Ingves, chairman of the Basel Committee: “My belief is that we’re in better shape once this is implemented but at the same time, it’s impossible to know what the future has in store.”
For the Basel Committee’s big guns, however, Christmas has come early. At the press conference announcing the news, the normally dour Draghi could hardly contain his excitement at finishing the 10-year regulatory marathon, saying he was “pleased and proud.”
Bjarke Smith-Meyer in Brussels contributed reporting.