The Basel Committee Rethink
Where things stand at present is that the Basel Committee is working to revise its accord. Some areas of focus include the trading book, treatment of securitization and resecuritization, pro-cyclicality, and the quality of capital. Basel II, of course, is not a legislative body, but a committee of national supervisors, historically from the G7 plus a handful of other countries, but recently expanded to include countries such as China, India, and Russia. It will be down to national governments to implement the new regulations. Within the European Union, this will be driven at a European level.
Already, as we have seen in the United Kingdom from the report on the banking crisis from Lord Turner, the head of the Financial Services Authority (FSA), which was released in mid-March, the UK regulations on liquidity and bank capital requirements are likely to be toughened up. Whereas previously a degree of “gaming” of the rules by banks was apparent, it is likely that in future there will be less tolerance for this. Already, commentators are talking about the need for greater simplicity in regulatory mechanisms, on the grounds that complexity makes the system inherently more difficult to monitor and understand. The difficulty with this, though, is that simplicity is potentially achieved at the cost of setting much higher capital ratios for banks, as well as curbing their activities.
Recovery for Banks Could Be More Difficult under New Rules
While the latter might be viewed as desirable to some market commentators, it will mean that banks may become less profitable and may, therefore, take longer to repair their balance sheets. Holding additional regulatory capital will have an impact on banks’ ability to lend, just as governments are doing their utmost to free up frozen credit markets. There is also an issue about the effectiveness of simple rules, which will not be well aligned to differentiations in risk, and may, therefore, encourage “gaming”, albeit perhaps in new forms.
The depth of the difficulties the market is now in is also related to the way in which some banks moved a great deal of their risk portfolio off their books, and into special investment vehicles (SIVs), perhaps as a means of funding positions in a more capital-efficient fashion. During the crisis, a number of banks were faced with either having to bring some of these portfolios back on balance sheet, or providing support to off-balance-sheet SIVs. Going forward, one can see much stricter regimes coming into play around SIVs, and banks in general will be focused much more closely on off-balance-sheet risk, even when this takes the form of exposures that they are not legally obliged to meet.