Said no one ever.
Regardless of where you live or which team you are on, bank or regulator, you are probably never completely satisfied with global bank regulation.
Granted, the regulation was not made to make anybody happy, but to curb systemic risk, especially in times of stress.
However, bank regulation has gotten complicated, not in the least because systemic risk exists on all levels from local to global, and that makes for a lot of jurisdictions and participants that aren’t always coordinated or consolidated.
In Europe, large banks are under more than seven different sets of requirements, some of which could work against the intentions of others in times of stress. And there are voices that say that regulation has tipped over into bureaucracy and needs reform, which most often means deregulation.
But as Michael Theurer, an executive board member of the German central bank, points out in a recent FT opinion piece, deregulation and simplification are not the same thing.
He suggests three areas where bank regulation can be simplified without jeopardizing financial stability.
- Only include common equity tier 1 (CET1), a bank’s common shares and retained earnings, in the capital requirement for absorbing credit losses. As Theurer says, CET1 is the strongest and first defense of a bank’s capital, and by designating it to (only) absorb credit losses, much capital suboptimization and misalignment can be avoided.
- Separate capital and resolution requirements. Currently, European banks are required to hold capital to absorb credit losses and ensure a smooth resolution if the bank gets into irreversible trouble. Both of these requirements include CET1 and other types of capital, so let us think this through: there is a recession, the banks’ credit losses increase, and they are absorbed by CET1. However, some banks might not make it, despite a chunky amount of CET1*, and will have to be dissolved and pay as much as possible of their liabilities with—you guessed it—CET1, but now there is no guarantee there is any CET1 left. It would therefore be a good idea to dedicate CET1 to going concern and some other part of the bank capital to resolution.
- Only require two capital buffers, one that the banks always have to maintain, and a countercyclical one that can be released in times of stress. This would be aligned with regulations in Canada, and what the US might be trying to do with eliminating the supplemental ratio (see The Risk Report).
Simplification alone might not be enough. Global bank regulation is only as good as those committed to following and enforcing it. In another recent FT opinion piece, Eric Thedéen, the chair of the Basel Committee on Banking Supervision and governor of the Swedish central bank, said that now is not the time to throw in the towel on bank regulation.
This year has seen a series of postponements of the implementation of the Basel III endgame. Some of the delays have no new deadline, others are contingent on the US catching up from being second to last (only slightly further along than Turkey). As of now, 70 percent of the committee members have already completed their implementation.
That exposes the global banking system to regulatory arbitrage or a race to the bottom. In good times, less regulated banks have a competitive advantage over those more regulated. It might even cause international banks to set up shop in places with less regulation. However, in bad times, the less regulated are more likely to fail, and that might be fine if there is no risk of the failing banks taking the whole system down with them due to loss of confidence and global interconnectedness.
The Global Financial Crisis (GFC) of 2008 was a painful example of what realized systemic risk can cause: recession, job losses, housing market collapse, bank failures, and expensive bailouts. This is what got us into Basel III in the first place.
So while we might not have gotten banking regulation just right yet, that is no reason to get rid of it altogether.
*Remember, capital ratios are meant to lessen loss of confidence and contagion in the banking system, not necessarily prevent individual banks from going down.
Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.
This article is part of the FRG Risk Report, published weekly on the FRG blog. To read other entries of the Risk Report, visit frgrisk.com/category/risk-report/.