'Basel Is on Life Support' in Trump Era
WASHINGTON – Basel's days may be numbered.
That's the conclusion of Wall Street critics, industry observers and bankers, who see political support for the international capital accord at an all-time low.
The accord was already in danger prior to the election of Donald Trump as president, with the European Union threatening not to follow through on the final rules. But the president-elect may hasten Basel's demise, given recent statements from those in his transition team.
"As regulations are given from Basel into the U.S. financial regulators, we now have kind of an agreement … where the U.S. is absorbing regulatory guidance, regulatory suggestions from the international community," said David Malpass, a senior economic adviser to Trump, in a speech last month. "New York and Washington and are benefiting from an international financial system which is leaving millions and millions of people around the country … out, so part of the goal is to create a financial system that works for the average person rather than for the financial elite."
Trump himself may have been alluding to Basel when he warned in a speech in October that his rival Hillary Clinton was cutting deals with foreign powers.
"Hillary Clinton meets in secret with international banks to plot the destruction of U.S. sovereignty in order to enrich these global financial powers for her special-interest friends and her donors," Trump said. "My question is, do you believe that? And if not, how can you support someone who does?"
Ironically, the possible end of Basel comes as it was nearing the finish line – and is a complete reversal from the days after the financial crisis, when regulators across the world agreed that tighter safeguards were necessary.
Basel III was a response to the financial crisis, and a repudiation of Basel II, which relied on large banks' internal models to set capital standards. Instead, Basel III set higher minimum capital requirements for the most systemically risky banks, rules for previously unregulated over-the-counter derivatives, liquidity requirements, and other standards. The Basel Committee on Banking Supervision is slated to complete the last of these rules by the end of the year.
Congressional Republicans have been critical of the Basel accords for some time. Outgoing Senate Banking Committee Chairman Richard Shelby, R-Ala., has said U.S. regulators' discussions with their international colleagues are opaque and outside the scrutiny of Congress. U.S. banks have similarly criticized regulators for "gold-plating" Basel rules by setting out even more stringent requirements than those mandated by the international accord.
Some observers herald recent developments as a welcome change.
"It would be great if we just told Basel, 'No thanks, we are not doing this anymore.' I don't buy into the whole international cooperation stuff," said Norbert Michel, a research fellow with the Heritage Foundation. "You could easily implement a simple requirement, a simple flat requirement that would exceed [Basel's] capital requirement and be compliant without having to go through all that" additional complexity.
But others warn that abandoning Basel could have grave consequences. Karen Shaw Petrou, managing partner at Federal Financial Analytics, said the accords may not be perfect and certainly have aspects to them – particularly the final round of rules – that may not be strictly in the U.S. near-term interests. But the accords are there to prevent global financial catastrophes, not boost short-term growth, and however flawed they may be, discarding them and replacing them with nothing isn't a smart move.
"It's absolutely true that Basel has been proposing some things that at least I think are not good for the United States – we have a different financial system, too," Petrou said. "But this really uneasy structure was designed fundamentally to prevent that lowest-common-denominator race to the bottom."
Ed Groshans, an analyst at Height Securities, agreed, saying the long journey toward Basel III started with simpler, far more flawed iterations in Basel I and Basel II – until international regulators finally agreed that banks need to be better capitalized and should have common prudential structures.
"Getting away from it is probably pushing us too far," Groshans said. "It has been a very long, arduous journey to get Europe, Japan and the U.S. all at least thinking about capital in the same way, thinking about the risk to capital in the same way."
But it isn't just the Trump team that is questioning the Basel rules. The European Union has been warning the Basel Committee that if the final rules do not help boost growth for member states, the Continent will develop its own regulations and ignore the international standards. Basel committee officials and members have said that the final rules would not represent a significant increase in overall capital requirements.
Ed Mills, managing director at FBR Capital Markets, said that the international mood simply is not breaking Basel's way, and that Trump's election is a reflection of that pro-nationalist sentiment, not the cause of it.
"The U.S. is not the only place where nationalism is on the rise," Mills said. "Basel is on life support. I don't know if it is at its end."
Greg Baer, president of The Clearing House, said the comments coming from Trump's camp are really just a matter of U.S. leaders catching up to the attitudes already prevalent around the world – that ever-higher capital standards are hard to sell in an atmosphere of stagnant economic growth.
"The current pressure on the Basel process is not coming from the incoming administration but rather from European and Asian governments that have concluded the Basel rules are a hindrance to economic growth," Baer said. "The U.S. banking agencies thus far have resisted calls for an EU-like call for evidence on economic policy impacts, and seem to be the only ones calling for still higher capital."
The Basel Committee is slated to meet in Santiago, Chile, on Tuesday to reach recommendations for the final rules to recommend to the governors and heads of supervision. Greg Lyons, a partner with Debevoise and Plimpton, said what they conclude could be the difference between whether the international standards – and the committee itself – has any influence on global affairs in the near future.
"There are two questions: One is, Where does the committee end up? and the other is, Wherever they end up, do the countries follow them?" Lyons said. "If you're the Basel Committee, do you do what you think is right? Or do you soften the rules to maintain the stature of the Basel Committee for fear that, once you've been rejected on something, you become a committee of mere suggestions rather than having the force you historically have had?"
Another question is exactly how aggressive Trump and his administration will attempt to be in negating the Basel accords, and how quickly and completely they will be able to do so even if they are determined. Mills said that Trump's two vacant seats on the Federal Reserve Board and an open seat for vice chairman for supervision, as well as near-term vacancies atop the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, mean that the reversal could begin quite quickly.
"This is almost done entirely through regulation," Mills said. "Basel ultimately is a recommendation. It is up to each country to implement it as they see fit. The vice chair positon and the two open seats are key to this."
Groshans disagreed, saying the Fed in particular is not an institution that turns on a dime. Moreover, he said, the standards are intertwined with U.S. law in such a way that might require legislation to untangle them.
"It would seem odd for the Fed, which has been an instrumental entity providing input to Basel, to just start tacking a different way," Groshans said. "The Federal Reserve has adopted these capital standards, so if there is going to be a change to capital standards it is going to need to come from legislation."
Lyons said that, because the portions of the accords that are now in place have gone through independent bank regulatory agencies, steering those agencies away from the accords will take time, even with top appointments. The more immediate effect would not be a reversal, he said, but an immediate halt to any new implementation.
"It would be a big move to completely dispose of Basel," Lyons said. "I don't think it would be the first thing on his agenda, but I would put it as another brick in the wall rising against international agreement."