Photographer: Martin Leissl/Bloomberg

What Global Bank Regulators Are Fighting About: QuickTake Q&A

Rarely have the people who look after the global banking system argued so stridently or so publicly. The members of the Basel Committee on Banking Supervision are struggling to complete an overhaul of capital standards intended to strengthen the world’s biggest lenders. A compromise deal remains elusive, forcing the postponement of a Jan. 8 meeting at which the regulator’s oversight body was scheduled to endorse the new rules. The most vocal demands have come from Europe, where policy makers want to shield already struggling banks from even stricter regulations.

1. What’s Europe so upset about?

The Basel Committee is revamping the way banks calculate the risk of their assets and the capital they need to cover that risk. European Union banks including Germany’s Deutsche Bank AG and France’s Credit Agricole SA have lobbied hard against the plan, warning that it could saddle them with hundreds of billions of dollars in additional capital charges. Top EU policy makers have joined the fight, arguing that significantly higher capital requirements would impede lending and hit European banks harder than their U.S. peers.

2. Why are changes needed?

The 2008 financial crisis showed that banks had taken on too much risk. The regulators’ response was Basel III, rules intended to bolster banks’ capital base and improve their ability to manage losses. What’s under discussion now is the last piece of Basel III.

3. What’s the problem?

There are two ways for banks to assess the risk of their assets, such as real-estate loans and corporate and infrastructure lending. Most firms use standard formulas set by the regulators. The big banks, however, can use their own risk-assessment models, subject to supervisory approval. The Basel Committee found that these models too often underestimate risk, resulting in insufficient capital requirements. In other words, banks are gaming the system.

4. What’s the cure?

The Basel Committee is overhauling the standard formulas for calculating credit and trading risks as well as operational risk, which covers the impact of things like litigation, misconduct and cyber crime. It also wants to cap the benefit banks gain by using their own models. Under the most recent proposal, modeled results couldn’t drop below 75 percent of the result yielded by the standard formula -- a so-called output floor.

5. What does Europe want?

Top policy makers such as Valdis Dombrovskis, the EU’s financial-services chief, have called for this output floor to be scrapped altogether. It wasn’t terribly surprising, then, when Germany pushed back against the draft compromise. European bank lobbies said that if the floor is to stay, the level has to come down. The Basel Committee is considering a range of 60 percent to 90 percent.

6. Why is Europe shouting the loudest?

Europe’s economy is far more reliant on bank financing than many other markets, such as the U.S., so the link between lenders and growth is more direct. Also, European banks tend to keep mortgage risk on their balance sheets more than U.S. banks, which can offload it to Fannie Mae and Freddie Mac. This makes European banks more avid users of risk models, and leaves them more vulnerable to the Basel Committee’s proposed changes.

7. What happens next?

The Basel Committee’s oversight body delayed a Jan. 8 meeting to allow more time to “finalize some work, including ensuring the framework’s final calibration.” The regulator “is expected to complete this work in the near future,” according to a statement published on Jan. 3. Remaining issues should be resolved in the first quarter, according to a person with knowledge of the discussions. Once the Basel Committee reaches consensus on completing Basel III, the oversight body, whose next meeting could come in mid-March, must approve the final standards.

8. Why the urgency?

Regulators have been working on this international framework for nearly a decade. “It is important to many parties, not least banks, investors and policy makers, to clarify how the global regulatory framework for banks will function,” Basel Committee Chairman Stefan Ingves said in November. There’s also a sense that the work should be finished before President-elect Donald Trump has time to reshape U.S. policy, given that he has vowed to dismantle financial regulations.

9. What is the Basel Committee, anyway?

Created in the mid-1970s, the Basel Committee brings together authorities from around the world including the U.S. Federal Reserve, the European Central Bank and Japan’s Financial Services Agency. It sets minimum standards for the supervision and regulation of banks, including rules on capital. National authorities then enact these standards as they see fit.

The Reference Shelf

  • An article on Germany’s opposition to a compromise floated by the Basel Committee.
  • European banks are going to the mat on the output floor.
  • Europe just isn’t ready for U.S. bank rules, Bloomberg view columnist Leonid Bershidsky writes.
  • A Nov. 10 speech by Basel Committee Chairman Stefan Ingves that sets out the case for reform.
  • The Basel Committee’s March proposal on "reducing variation in credit risk-weighted assets."
  • Information on the Basel III international capital framework.
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