Friday, December 14, 2012

Basel III complacency

Basel III is supposed to be a tough answer to Basel II- better quality capital and more capital for banks. Banks have resisted the higher requirements saying it they will affect loan growth. It is sobering to be reminded, therefore, that equity to total capital at banks, following Basel III, will be a mere 3%- that is, a leverage of 33! The reminder comes from the Vice Chairman of America's Federal Deposit Insurance Corporation:
Despite the promise of higher capital levels and better quality capital, Basel’s new minimum leverage ratio requirement is only 3 per cent, about the same as that of the largest US banks when the global crisis erupted. Basel III offers more complexity and, therefore, new opportunities to circumvent the system. But it does not offer any more certainty that banks will be well capitalised when the next crisis hits.

What is the answer? Go for a simple leverage ratio that is reasonably high:
We can establish a simple but stronger capital base by replacing the unmanageably complex Basel risk-weighted standards with a tangible equity capital ratio of around 10 per cent, and use a simplified risk-weighted measure as a check against excessive off-balance sheet assets or other factors that might influence banks’ safety. If the financial industry had had tangible equity capital approaching this level in 2008, we might still have had a crisis. But it would have been far less severe and far less costly to the public.