All Articles Finance This Week in Basel - March 4

This Week in Basel – March 4

Basel III monitoring results, Caruana on peak finance, CPMI on blockchain, Borio and Gambacorta on lending and is Basel too soft on G-SIBs?

8 min read


BIS General Manager Jaime Caruana

BIS General Manager Jaime Caruana - Photo credit: Sebatien Bozon/AFP/Getty Images

A weekly roundup of news and information eminating from and related to the Bank for International Settlements (BIS) in Basel, Switzerland.

Basel III regulatory reforms are working really well for US banks

The Bank for International Settlements collected data from 210 banks and found “virtually all” met Basel III minimum and target CET-1 capital requirements. The report is based on data as of June 30, 2016 and includes all 30 banks that have been designated as global systemically important banks (G-SIBs). Right about now it is interesting to note that during Q2 of 2016, the 8 US-based G-SIBs reported combined earnings of approximately $25.2 billion. More broadly, the FDIC announced this week that the US banking industry set a record in 2016 with combined net income of $171.3 billion. That was followed by the release of a study from BCG that found the banking sector as a whole has paid $321 billion fines since the financial crisis; with North American banks accounting for about 63% of the total fines, or approximately $204 billion. In 2016, North American banks coughed up $22 billion in fines.

We hear a lot from banks about how difficult it is to operate and turn a profit in an era of beefed up regulations. We also hear from policymakers, particularly in the US, that the time has come to roll back financial regulatory reforms because they are too stringent. But in 2016, banks were able to pay billions in fines, meet Basel capital requirements, navigate massive amounts of political uncertainty … and still produce record profits.

It is also no secret that the relatively speedy response of US regulators to the financial crisis of 2007-08 helped put US banks on a more rapid road to recovery than banks in other regions, particularly Europe. In fact, the position of US banks is so superior that at least one analyst thinks US banks will start buying up European lenders as soon as next year.  

On top of everything else, it is worth noting the global financial system has also enjoyed relative stability.

So maybe – just maybe – the position of strength where US banks now find themselves is because of financial regulatory reforms, not despite them.

But that doesn’t mean the US won’t mess things up

Basel Committee Chairman Stefan Ingves wrapped up this week’s meeting of the Committee by issuing a statement about how the group is committed to reaching an agreement on the finalization of Basel III reforms, namely revisions to the risk-weighted asset framework, the leverage ratio framework and the output floor. However, the truth is that the Basel Committee is seemingly at the mercy of the Trump administration. Trump has yet to name a new Federal Reserve official responsible for banking supervision. Even after that appointment is made, it remains to be seen if the US will walk away from the Basel Committee negotiations, work toward an earnest agreement or just agree to the reforms and then return home with no intention to implement or enforce them.

Is the Basel Committee going easy on G-SIBs?

The top of this column leads with news that “virtually all” banks met Basel III minimum and target CET-1 capital requirements. But what if banks are hitting those goals because the goals, or the formulas used to calculate them, are erroneous? Wayne Passmore and Alexander H. von Hafften of the Federal Reserve suggest that might very well be the case with regard to Basel’s capital surcharges for G-SIBs.

“Overall, our best estimate suggests that, although Basel’s method of measuring systemic importance may be valid, its current G-SIB capital surcharges are too small based on the experience of the 2007–09 financial crisis. Our best estimate of an empirical implementation of the G-SIB capital surcharges would (1) raise capital requirements 375 to 525 basis points for banks currently subject to G-SIB capital surcharges, (2) create an additional lower bucket with a capital surcharge of 225 basis points for very large and systemically important banks that are not currently subject to any G-SIB capital surcharge, and (3) include a short-term funding metric that further boosts capital surcharges 175 to 550 basis points for banks that fund assets with a high proportion of short-term funding.”

Passmore and van Hafften might be right or they might be wrong; but no matter what they are brave. For researchers at the Federal Reserve to push for higher capital surcharges for G-SIBs amid the current political climate swirling around the Fed takes courage. I hope they have dusted off their resumes…

Caruana on peak finance

BIS General Manager Jaime Caruana lectures on the key role global financial integration can play in powering economic growth and innovation. To that end, Caruana says that despite some outward appearances, the peak level of global financial integration has not yet been reached. In comments that seemingly targets populist/insurrectionist movements sweeping countries around the world, Caruana stresses the importance of dealing properly with what he describes as “a clear and present risk of a political reaction to global finance.” Caruana also outlines the dangers that lie in allowing the notion to take hold that the very best benefits of “peak finance” have been realized.

  • If one thinks that peak finance is passed, then one may believe that there is less harm in policies that interfere with the free flow of capital.
  • If one thinks that peak finance is passed, then one may believe that there is less harm in polices aimed at keeping national savings for one’s own workers.
  • If one thinks that peak finance is passed, then one may believe that there is less harm in choosing purely national regulatory solutions and in reducing international cooperation at the risk of fragmenting financial markets.

While Caruana succinctly states the case for “peak finance” and aptly describes the threats it is facing, his comments lack real-world ideas about how to convince naysayers that such global financial integration is in their favor. The rise of populist/insurrectionist politicians has been powered by large swaths of voters who have seen little to no benefit from what they were told would be economic and financial advancements. They feel left behind. So while Caruana argues that “peak finance” just needs more time to take hold, he and other proponents of global financial integration need to come to grips with the fact that de-globalization got its start and is well underway because those left behind got tired of waiting.  

Blockchain, Blockchain, Blockchain

The Committee on Payments and Market Infrastructures issued a report that offers a framework for analysis of distributed-ledger technology (DLT) in payment processing, clearing and settlement. The upshot is that DLT, aka blockchain, has tremendous potential, but it is too early to tell just how dramatic an impact it will have on financial markets. I am most curious to see how blockchain will affect the way the BIS itself does business. As the “central bank for central bankers,” it seems blockchain might revolutionize the way the BIS conducts transactions. And more importantly, what kind of impact with that revolution have on the fees the BIS charges for its services?

The BIS analyzes bank lending amid low interest rates

Remember how during the dark days of the financial crisis, central banks struggled to understand why continued cuts to already low interest rates failed to boost real-world lending? Well, Claudio Borio and Leonardo Gambacorta from the BIS analyzed that scenario and found that once rates are low, further cuts don’t always have the effect on lending that central banks desire. Interestingly, Borio and Gambacorta expended their research to include non-crisis times and banks at various stages of the business cycle.

“Our analysis suggests that, at very low interest rates, further reductions in short-term rates may be less effective in boosting lending. This result holds after controlling for business and financial cycle conditions and different bank-specific characteristics, such as liquidity, capitalization, funding costs, risk and income diversification. Importantly, it does not appear to reflect exclusively the impact of a financial crisis on banks or weakness in loan demand. This indicates that other mechanisms may be at work. We have suggested that a plausible one may be the impact of such low rates on the profitability of banks’ lending business, as low rates sap net interest margins. A simple back-of-the-envelope calculation indicates that the impact can be material.

Now it’s not very often that you see BIS research cite “back-of-the-envelope” calculations, but Borio is the no-nonsense guy who is head of the Monetary and Economic Department in Basel, so I guess we can trust is envelope calculating skills. Nevertheless:

These results have implications for policy. They point to another possible channel through which monetary policy may become less effective at very low rates, ie to another version of the pushing-on-a-string argument. In this case, the channel operates through the impact of low rates on the profitability of banks’ lending business and hence on their incentive or ability to supply loans.”

The paper is a pretty damning indictment on a key theory many central bankers have long held dear: Reducing rates spurs lending.

However, anyone who was trying to get a loan on Main Street circa 2009 could have told you that theory was rubbish back then.

TWIB Notes

  • Are low yields on long-term government bonds a sign of prolonged future economic stagnation and deflation? BIS Economic Adviser and Head of Research Hyun Song Shin says not necessarily.
  • Sam Woods, deputy governor for prudential regulation at the Bank of England, on capital requirements
  • US-EU insurance covered agreement faces an uncertain future