Defined Terms and Documents
Regulatory madness in the banking world
Albert Einstein is reported to have defined insanity as doing the same thing
over and over again and expecting a
different result.
Einstein may, or may not, have formed this view while doing his Nobel
Prize-winning work at the Swiss Patent Office in Zurich, but it does seem to
apply to banking regulators in the Swiss city of Basel.
The Basel Committee is the premier banking regulator in the world and sets the
rules for all other countries, including the Australian regulator, APRA.
This week, the committee published its latest set of rules, named Basel III, and
like Jaws and Rocky,
this multi-numbered franchise seems to have run out of steam.
One can sometimes forgive the committee for being incomprehensible (as
regulators go to great pains to be opaque) but it is hard to put up with their
inability to face up to the fact that doing the same as before, except more,
will not cure the global banking system.
The introductory paragraph to the new Basel III rules does a very good job of
laying out the causes of the Global Financial Crisis (GFC), namely excessive
credit leverage and the complexity and interconnectedness of the financial
system. But, the Basel Committee then goes on to propose the same old tired
remedies, even though they readily admit that they failed in the past.
The key tool in the Basel toolbox is 'capital adequacy', and the belief that if
banks hold sufficient capital they can weather any storm. In practice during the
GFC, even the best-capitalised banks had to go cap in hand to governments or
sovereign funds, or be taken over, or be nationalised.
Of course, banks must have sufficient capital to cover losses but that is a
necessary but not sufficient condition – they must also have prudent management
and good risk management systems.
Basel admits that the industry, pre-GFC, was plagued by bad risk management but
does not acknowledge that they, through their so-called Pillar 2 regulations,
had set the rules for the banking risk management that subsequently proved so
disastrously inadequate. Their final regulatory weapon, Market Disclosure, has
proved a complete damp squib, producing so far only the less-than-transparent
quarterly Risk and Control report, which few people know about and even fewer
read.
This does not mean that Basel II was responsible for the global crisis, only
that their defences were as weak as a New Orleans levee in the face of Hurricane
Katrina.
Basel is hated, on one hand by conspiracy theorists, who believe that the
committee is some form of shadowy 'World Government' and on the other by bankers
who believe that they stand in the way of unrestrained profit seeking. Expect
bankers, in particular, to scream very loudly when the changes in capital
proposed in the new Basel III rules begin to bite on profits.
But governments should also be worried.
Without admitting any complicity, the committee recognised that the intricate
set of capital calculations proposed in their previous rules did not work in
practice, because in the good times the bigger banks kept less capital than
needed to see them through the bad times.
To counteract this tendency to spend today, Basel III has introduced the concept
of 'counter cyclical buffers', which, stripped of its 'macro prudential' jargon,
means putting a little away for a rainy day.
The committee is therefore introducing a regime that, in its own words "will
adjust the capital buffer range, yada yada yada, when there are signs that
credit has grown to excessive levels”. In layman's language, if credit is
growing too fast, regulators will slam on the banking brakes.
Maybe Glenn Stevens, governor of the RBA, should pick up the phone and call the
committee and quietly, but firmly, tell them to rack off - that is not their
job!
It is the job of a banking regulator to ensure a sound banking system and,
within that, to ensure that the failure of an individual bank does not cause
contagion in the system. After that, they just 'may' have a tiny responsibility
for ensuring that an individual bank does not fail. But, it is not the
regulator's job to determine macro-economic policy.
Like any regulatory institution, banking supervisors will be working on
out-of-date data. Can you imagine the situation where the RBA is trying to
stimulate the economy as it is beginning to struggle out of a downturn and the
regulator is simultaneously slamming the brakes on bank lending because it is
using old data from the depths of the previous recession?
Unless, and until, there is proper democratic accountability over their
decisions, banking regulators should not be given such powers. Yes, of course,
banking regulators are part of government but they are not staffed for, nor
should they be, a party to macroeconomic decision making, such as the tightening
or loosening of credit.
Lest you think that this is merely a topic for regulatory propeller-heads,
shareholders should also note that in certain circumstance, to preserve the
wonderfully-named Capital Conservation Buffer, regulators may 'reduce the
discretion' of bank boards to distribute earnings! With capital and remuneration
constraints and possible restrictions on dividends, why do we not just go the
whole hog and let the Government appoint all bank directors?
Even if the new Basel III rules were good (and some are certainly worthy of
consideration), the chances of successfully averting another crisis are low
because the Basel process is irretrievably broken. The last set of rules, Basel
II, took almost a decade to be agreed and implemented through a protracted,
tortuous and totally opaque consultation process and, even then, did not include
the USA, one of the primary sources of the GFC. The current target for full
implementation of Basel III is 2018, which, on past experience, will likely slip
out into the 2020s. There have been two market upheavals in the first decade of
the 21st century (the dot-com bust and the GFC), how many more will there be
while we wait for Basel III to work?
The Global Financial Crisis has proved that good banking regulation is essential
to the health of the global economy (and the hip pockets of taxpayers). But,
before spending many millions of dollars on yet another experiment in banking
regulation, someone, such as the IMF or
World Bank, should take a dispassionate look at the successes and failures of
the Basel series of regulations and make a determination as to whether they are
more, or less, likely to work next time.
If not, Basel III strikes and you are out!
Dr Patrick Mc Connell is
a Visiting Fellow at Macquarie University Applied Finance Centre, Sydney.