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Dilution of Basel III Threatens Global Financial Stability

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The Basel Committee on Banking Supervision recently announced downward revisions to its liquidity coverage ratio.

The revised LCR still could increase global demand for safe assets – including investment grade corporate debt and highly rated bonds – by $2 trillion to $4 trillion. The International Monetary Fund estimates there are currently about $75 trillion of safe assets in the market today. These requirements now give global financial institutions until 2019 to fully develop liquidity buffers and could significantly relax the definition of safe, high-quality liquid assets. In extending deadlines and diluting these critical regulations, the financial industry missed a golden opportunity to build appropriately stronger liquidity buffers, strengthen stress testing and ensure global banking stability.

Every banker should be concerned that the diluted Basel regulations will now consider gold and sovereign debt as high-quality liquid assets. While Basel III proposes to give gold a “zero risk” consideration, remember that just saying an asset carries zero risk clearly does not make it true, regardless of who says it. Holding gold assets introduces another category of risk to any financial institution – gold commodity price risk – and gold is especially susceptible to market runs and price volatility.

This complacent mentality of “this too shall pass” may likely be the root cause of the next financial crisis. In fact, the next crisis may already be underway, as a debt crisis haunts the Eurozone and the U.S. looks to deleverage its massive federal budget. For now, we have found the coins in the couch for these governments’ insatiable debt appetites. Buyers of this debt will be financial institutions required to raise up to $4 trillion worth of high-quality liquid assets. Increasingly, banks will be bailing out “Too Big to Fail” governments.

Financial institutions would be wise to insist on less flexibility and more stringent inclusion in the list of which assets qualify as truly safe assets. The only way to properly evaluate these assets is to thoroughly consider all risk elements.

While fighting Basel III and largely ignoring the need for beginning implementation preparedness, U.S. financial institutions, and their lobbyists, have ironically missed the on-the-ground reality. The Dodd-Frank Act is the American version of the Swiss Basel III. Dodd-Frank requires systemic risk evaluation, brings transparency to financial regulatory processes and controls derivatives trading. Even if Basel’s requirements were to fall victim to complacency, Dodd-Frank embeds within it the very essence of the liquidity and capital requirements of Basel III. 

There is no denying the world has changed in irrevocable ways since 2007. Heightened risk has come to be expected, continued financial uncertainty is here to stay and economic growth will be steady but very slow. Led by the declining influence of U.S. and Europe, the balance of global economic power continues to shift, based upon population demographics and governments going bankrupt. More so now than ever before, our interconnected financial framework requires higher levels of capitalliquidity and investments in assets that can objectively be considered safe.

Orlando Hanselman is education programs director for Fiserv Risk and Compliance.

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Comments (1)
Hanselman's article really points to the fact that by lobbying against & watering down Basel III, banks are hurting the banking sector and the economy. Indeed the further away we move from the 2007 recession, complacency sets in and the seeds for the next crisis are sown. www.MRVAssociates.com
Posted by Mayra Rodriguez Valladares, MRV Associates | Wednesday, February 13 2013 at 8:02PM ET
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