The banking regulators of the major world economic powers will meet on Wednesday and Thursday within the Basel Committee, to work towards the finalization of the prudential measures decided in the aftermath of the 2008 financial crisis.
Launched since nearly two years, the negotiations are held within this instance. The initial proposals are intended to support the internal models used by banks to assess the risks of their assets. However, european banks have relied heavily on these models since their approval in the mid-2000s, where strong criticism of their own, but also regulators and european policy. The Tribune looks back on the stakes of these negotiations.
Bank regulation is a priority to fix the level of minimum resources, or capital ratio in the jargon, that must hold for the banks to be able to withstand a financial shock.
Since 2004, and the agreements of Basel II, banks can modulate their own funds requirements based on the risk of their assets. Gold, banking institutions not holding the same assets, the regulators have decided to allow them to develop their own models to assess the risks of their activities (credit, market, etc).
“Except that banks, with their internal models, have under-estimated the risk to apply in parallel a capital adequacy ratio lower gives Jezebel Couppey-Soubeyran, a lecturer at Paris-1 and is a specialist in financial regulation.
“A margin of maneuver to minimize the burden in equity”
During the crisis of 2008, regulators found that banks were more under-capitalized than over-capitalized. Result, they have quickly responded by amending Basel II in the following year, and then by signing the agreements of Basel III in 2010. These latter reinforce the capital requirement and to widen the perimeter of regulation, including liquidity risk, in order to improve the robustness of the financial system.
For the record, the recommendations of the Committee do not have binding value. The States must then transpose into their law. The agreements of 2010 have only been partially applied and, especially, “the use of internal models has not been questioned”, points out Jezebel Couppey Soubeyran. “The banks are holding because they provide a margin of maneuver to optimize the load of own fund”.
This week, the regulators will, therefore, discuss the follow-up of the entry into force of their recommendations and discuss a framework for these internal models. It will be a kind of deepening of Basel III, also known as Basel IV (we find the two expressions in the press to speak about the same negotiations, ed.)
Differences between American and European
The heart of the discussions concerns the use of internal models, but all banks are not affected in the same way. On one side, Americans and Canadians have never applied the Basel II framework and use an equity ratio simple, without weighting assets by risk level. On the other, the Europeans have largely developed their own internal models and to defend this process, which, according to the banks, better reflects the reality of their risks.
In 2010, regulators had settled their dispute with a compromise, the adoption of a leverage ratio set at 3%, a level little binding when we know that the american banks have applied a situated between 5% and 7%.
Today, the Committee debate on the introduction of a “floor”, in other words, a maximum permissible deviation between the level of risk obtained via the application of a ratio simple and the one obtained by the internal models. However, the european institutions could be forced to release up to 120 billion euros of additional capital by applying this floor, according to McKinsey.
Trump is a game-changer
In addition to the meetings this week, the Basel Committee will also meet in December. “I expect that agreement will be reached by the end of the year,” said the end of September Sabine Lautenschläger, member of the executive board of the ECB, during a press conference in Vienna, adding that a failure to achieve this would be a “serious mistake”.
“If agreement there is, it will be a minimalist agreement between the Americans and the Europeans, which will slightly restrict the use of internal models”, provides, for its part, Jezebel Couppey-Soubeyran. “I don’t think that Americans will fight tooth and nail because the next act Trump enough for them. The Europeans will have a voice.”
Donald Trump was elected on the promise to alleviate the financial regulation. In June, the u.s. Treasury, under the leadership of Steven Mnuchin, a former banker at Goldman Sachs, has published a series of recommendations for the development of the reform. On the menu, a modification of the application of international standards in capital adequacy, which should give an advantage to american banks.