The death of the Basel Committee has been greatly exaggerated
WASHINGTON — The winter of 2016-17 was a dark time for the Basel Committee.
Britain's vote to leave the European Union and the election of Donald Trump had ushered in an era of isolationism and suspicion of international organizations. The committee itself was showing potential fissures — leading some analysts to doubt its relevance — as members balked over the final details of Basel III.
But fast forward to the present, and dire predictions of the Basel Committee's impending demise have not been realized. An agreement on capital floors that had caused much grief among members was finally completed late last year, albeit with lower risk weights than expected and longer phase-in deadlines, and new regulators are supportive of Basel's mission.
“Despite the nationalist tendencies in many areas, I think there’s recognition that a strong banking system — both in the U.S. and globally — is important to everyone,” said Greg Lyons, a partner at Debevoise & Plimpton.
In the wake of Brexit and the 2016 U.S. election, such optimism was rare. At that time, the debate over capital floors in Basel III was intense, taking on a life of its own. Skeptics saw the changes as too extreme, referring to them derisively as “Basel IV.”
The negotiations had grown so laborious that the EU signaled that it would not implement the standards, despite assurances from Basel representatives that the final rules would not require significant increases in bank capital.
But in the end, the EU got on board with the deal.
Just last week, Federal Reserve Vice Chairman for Supervision Randal Quarles — a Trump appointee — defended the value of international forums like the Basel Committee and the Group of 20’s Financial Stability Board, saying the U.S. has a “strong national interest” in participating on those committees.
“To ensure a level playing field for our banks, we need to be able to influence those decisions,” Quarles said. “I think that we can improve their transparency — even they have acknowledged that. But I do think that we should remain engaged in them.”
Quarles comments came as U.S. officials appear to be floating his name as the next president of the FSB, to succeed Mark Carney. The governor of the Bank of England has headed the international board since 2011, but his term expires in December.
Andreas Dombret, the head of the Department of Banking and Financial Supervision at Deutsche Bundesbank, Germany’s central bank, said the Basel Committee's stronger position today is largely attributed to the completion of the final capital floors in Basel III. The committee’s ability to finish that agreement is a sign of continued buy-in from the U.S., he said.
“And at the end of the day, the United States agreed to this as much as anybody else,” Dombret said. “I feel that the finalization of Basel III is a proof that we can still work together in these multinational organizations. The Basel Committee’s credibility would have been in danger if it wouldn’t have been able to agree on Basel III, which it did. So that helped.”
Lyons said U.S. engagement on the Basel Committee and the apparent desire for a bigger role on the FSB reflect the fact that nothing is gained from being on the sidelines of international forums, and much can be lost. The U.S. is home to a large number of globally significant banks, he said, and both the banks and their regulators benefit from a level playing field and reduced opportunities for arbitrage.
“The U.S. has a strong voice on the Basel Committee, and so I think there is a recognition that … we can help to guide the Basel Committee in ways that are appropriate to the U.S. banking system,” Lyons said.
However, the fact that U.S. regulators appear determined to remain involved in global collaborations like the Basel Committee also means they will have to implement those international standards domestically — a prospect that could fuel fierce debate.
For one thing, clearer acceptance of international efforts by U.S. regulators could raise concerns in the financial services industry.
“One of the things that has always worried us is that these international standards are developed without a clear indication of how they will be applied in the U.S., and to whom,” said Hugh Carney, vice president for capital policy at the American Bankers Association.
Carney said that the ABA sees value in the Basel Committee and other similar forums, but that it is critical U.S. regulators take a more proactive approach to engaging with stakeholders than in prior administrations.
“Our hope is that the new appointees … consult with the public on what the goals of these negotiations are and what the details are before any final agreement is agreed to,” he said.
Dombret said members of the Basel Committee have recognized the need for enhanced transparency and are looking for ways to make their proceedings more accountable to the public.
The committee, for example, now publishes its agenda ahead of meetings, and a summary of the discussions afterward.
Concerns about accountability have to be balanced, however, with the fact that the committee is not a decision-making body — it is more like an informal club for central bankers and regulators to find common ground and global minimums for prudential standards.
“This is certainly no perfect democratic accountability, but it is the best available option to strengthen the informal club approach with transparency measures,” Dombret said. “Also, one should not forget that [it] is the national supervisors’ duty to consult with national politicians.”
To be sure, politics do play a role in the committee’s deliberations, as evidenced by the extremely lengthy and hard-nosed negotiations surrounding Basel III. In that case, regulators were trying to decide how stringent a member country’s risk-based capital standards were allowed to be relative to the committee’s standard risk-weighted capital standards. The U.S. favored a minimum that was closer to the Basel standard, while EU countries wanted greater flexibility.
Ultimately, Lyons said, the committee's agreed-to minimum capital standard of 72.5% of the Basel minimum was less than the 80% that the U.S. was calling for but more than Europe would have preferred. That deal was made possible by the fact that the debate was over a number, and the U.S. was willing to let that number drop in order to reach an agreement.
“I would bet you that what the Basel Committee put out in December is very different from what they thought they were going to put out a year beforehand,” Lyons said. “I don’t think it’s nearly as strong … and I don’t think they were heading that way previously. In some sense, you can always reach a consensus by dropping the standard.”
Dombret said the agreement was critical to maintaining the Basel Committee's legacy as a unique venue for the negotiation and crafting of uniform banking standards.
“Let’s be clear on this: the Basel Committee is a body where things got done of an important practical value over the last few decades,” Dombret said. “It would have been very bad if, for example, over the finalization of Basel III, this committee would have broken.”
But the ABA's Carney said it remains unclear how the agreement reached in December will be implemented in the U.S. Those details — particularly whether the standards will apply to all banks or only to the largest banks — are crucial, and could help determine whether the banking industry favors the standards or not.
“We have very little understanding of how this standard could be adopted in the U.S., considering various existing regulations and legislative constraints that are a part of Dodd-Frank,” Carney said. “There are parts of the Basel IV agreement that are harsher than existing treatments, and there are parts that are more beneficial. It’s a bit of a balance, but I don’t think you can get feedback from the industry without highlighting to them what the potential scope is.”
Dombret said the committee’s successful navigation of countries' differences in finalizing an agreement over capital floors will now give way to evaluating countries’ implementation plans and monitoring progress in putting the standards into practice. Some remaining items, such as finalizing the "fundamental review of the trading book," are potentially significant, but pose less of a threat to the credibility of the committee.
“We have gone from a phase where we have been thinking up regulation to a phase of implementing [rules] and checking that implementation has been done in a way that was designed,” Dombret said. “It has become a little less sexy in terms of content, but not less important.”