Report on ILF conference: -Basel III Are we done now?- by Thomas Seidel

The headquarter of the Bank of International Settlement in Basel
The place of the regulations name
(Copyright: wikipedia, licence Freie Kunst)

Only last December, after nearly ten years of tough negotiations, has it come to pass the new global regulations Basel III for the financial industry. We had already reported about it. (Insert here the left). Essentially, Basel III is designed to help reduce the potential for another devastating global financial crisis. Now is the time to discuss with experts what the agreement on Basel III has brought. The Institute for Law and Finance (ILF) did it these days in Frankfurt am Main.

To cope with this complex matter, the event was divided into several discussion groups, each dealing with sub-aspects. The introductory lecture was given by Stefan Ingves from the Swedish Riksbank, who headed the Basel Committee until the end of the negotiations. Ingves immediately starts his remarks with a core problem. The long, over five-year, implementation period for Basel III. Of course, it could come in this period to new conditions, which then lead to renegotiations of Basel III. However, Ingves warns against questioning what was achieved. Ingves also gives an example, such as the accelerating cyber risks. What could not be implemented was an adequate consideration of public debt. On this and another topic, such as the Floor, which is known to have be traded down by the German representatives from 80 down to 72.5 percent, it becomes clear under what political pressure such talks take place.

A milestone achievment?

The first panel dealt with the question of whether one would have reached a milestone now? Participants were amoung others: William Coen, Secretary General of the Basel Committee, Andreas Dombret, Board of the Deutsche Bundesbank, moderated by Nicolas Veron, Senoir Fellow at Bruegel.

Panel I: f.l.t.r. William Coen, Stefan Ingves, Andreas Dombret,
Michael S. Gibson, Nicola Veron
(Copyright: Thomas Seidel)

The possibilities presented by Basel II for the first time, with which banks were able to calculate their risks according to internal risk models, have probably caused problems especially for financial supervision. But internal models would also benefit as long as the banks and a financial regulator have agreed on the approach. In addition, they would have to fit into the respective national systems. Regarding the effort of regulation under Basel III, the rules were never meant for small banks. Now is the time for a regulatory break. The rules have to be implemented first of all. It is to be regretted that the topic of public debt could not already be included in the new regulations. But the view of the US on the question of sovereign debt is clearly different from that of the Europeans.

Sence and Sensitivity

The second panel dealt with the proper handling of the rules and regulations, with participants such as Sabine Lautenschläger, Vice-President of the SSM, Olivier Guersent, Director-General of the European Commission and there, among other tasks, responsible for financial stability, Paul Hilbers, De Nederlandsche Bank; moderated by Patrick Kanadjian of Davis Polk & Wardwell London.

Panel II: f.l.t.r. Olivier Guersent, Sabine Lautenschläger, Paul Hilbers,
Patrick Kanafjian
(Copyright: Thomas Seidel)

Assessing risks is very difficult. It also needs the right financial supervision capacity, which in turn needs time to qualify for the application of Basel III. Basel III provided a framework and set the right incentives for the banks. Having a global standard is more important than discussing the height of a floor. The consequences of the new capital requirements are bearable for the financial sector. The EU Commission estimates the extended capital requirements on average at 30 percent. However, this is justifiable because of the long transitional period. But the banks should not only deal with Basel III. There are also other challenges, such as the changing markets and cyber risks. Nor should one let oneself drift of the markets. The conversion period is now nine years and there would be (formal) no reason to be finished before. New risks, such as Operational risks are currently difficult to model because there simply is not enough data available.

Have we gone far enough?

Whether one went far enough with Basel III, the participants of the third panel talked about. With Isabel Schnabel from the University of Bonn, who also is a member in the German Council of Economic Experts and Charles Goodhart from the London School of Economics, two well-known critics spoke. 

Panel III: f.l.t.r. Charles Goodhart, Isabel Schnabel, Douglas Elliott
(Copyright: Thomas Seidel)

Ten years after the financial crisis, do we even know what the objection of the new rules were good for? The rules on capital adequacy are in favour of the financial industry. In this respect Basel III went not far enough. Banks are actually legal entities. They have no feelings, no intelligence, no ethics and no risk awareness. It's more about the bankers, who make up a bank. The managers have the wrong incentives to make more and more profit quarter after quarter. Big bonuses are the wrong incentives. Financial supervision would have to relate much more to the bankers than to the banks themselves. But the supervisors are still not qualified, i.e. when it comes to the complexity of a mortgage loan. Another mistake is, to focus on the capital resources of the banks, rather than to pay attention to their liquidity.

What Basel III means to Investors

In a fourth panel representatives of investors will speak and discuss what Basel III means for them. Contributions came from Laury Meyers of the rating agency Moody's Europe, Stuart Graham of Banks Strategy and Philippe Borderau of Pimco Europe. 

Panel IV: f.l.t.r. Philippe Borderau, Stuart Graham, Laury Meyers, Levin Holle
(Copyright: Thomas Seidel)

The substantive essence of the statements of these participants, however, reflects a different attitude. Ultimately, investors don't care under wich conditions banks have to make their business, and even the investors don't care about the banks themselves. They simply calculate how much profit and what profit maximization they expect from corporations and direct their capital to where they think is most profitable.

Conclusion

The disagreement in the sovereign debt issue makes it clear how politically the whole subject of banking regulation is handled. The eternal haggling over the smallest compromises happens not only in government formations. But ten years is too long a period, even to achieve anything on a global scale.

The weaknesses of financial supervision were made quite clear by this event. After a quite advanced approach to risk calculation was formulated in Basel II with the internal models, the regulators in particular have proved to be overburdened. This is partly due to the lack of economics prerequisites of the supervisors, but also because the supervisors have overseen the banks confrontational rather than cooperative for too long. It gives hope that it is the representatives of the supervisors themselves who have recognized and named these deficiencies. One can therefore expect that Basel III lead to a reorganization and qualitatively orientation by the supervisiors itself.

The audiance was part of an intensive discussion
(Copyright: Thomas Seidel)

Having focused too long on capital- and less on liquidity requirements are true words. There is a drastic need for action in the liquidity topic. This is mainly addressed to the central banks, which have the means and the ability to ask the banks for sufficient liquidity, for example, through the minimum reserve, in the short term.

Regarding the missing data base for the assessment of operational risks, the supervisor should let the internal error reports of the banks be disclosed for evaluation of the last ten years. It will be astonishing how inadequate the processes, how IT is perforatet and how unqualified the acting staff of today is, at all levels in the banks. Charles Goodhart says it as clearly as necessary: ​​Not so much the anonymous banking company, but the bankers themselves should be the focus of supervision. This is especially true for top management. Goodhart has also made an accurate statement. People do not want the banks to be closed, they want the bankers to be punished for their misconduct.

The whole system of bonuses, quarterly reporting and transparency obligations leads to completely wrong incentives. Instead of stable long-term growth and sustainable investments, only short-term profit maximization is in the foreground. No participant described the profit-driven obesity of the current system as emotionless as Stuart Graham for stock investors. Only the here and now counts. A future, for whomever, does not matter.