As leaders of the Group of 20 leading nations meet in Seoul, they must decide whether to recommend additional capital and liquidity requirements for banks above and beyond those proposed by the Basel committee. They should proceed cautiously. There is a point beyond which more is not necessarily better. Hiking capital and liquidity requirements further could have significant negative impact on the banking system, on consumers and on the economy.
Basel seeks to address some of the reasons why the financial system fell into crisis, including over-leverage, pro-cyclicality, and unlevel playing fields. On the issue of leverage, I support Basel’s new higher capital requirements and expect my company to meet and exceed them well ahead of schedule. I believe they will make the system safer – in part because changes in risk weightings make the new requirements higher than they seem. Under Basel III the advertised 7 per cent is really more like the old 12 per cent. That is a substantial level and, with proper regulatory supervision, more than enough to stabilise the banking system.
But in the two other areas, risk management and calibration, the Basel architecture is either silent, does not go far enough or makes the problem worse. It worsens the pro- cyclicality problem, for instance, by reducing capital requirements in good economic times – an inducement to banks to begin over-leveraging again once they feel the worst is behind them. Improper calibration also fails to level both the institutional and geographical playing fields. Different kinds of institutions are regulated differently (and some not at all) while different countries are allowed to implement as much, or as little, of Basel as they like. These unlevel playing fields will chase capital out of the highly regulated formal banking sector and away from countries with strong rules and into new, less regulated or unregulated shadow banking systems. Overall risk in the financial system will rise. More capital will not solve either of these problems.