Fed Nominee Quarles Seen Breaking Ice in Basel Rule StandoffBy , , and
Quarles awaits confirmation by Senate as Fed vice chairman
Basel Committee meets Oct. 4-5 on completing capital framework
Bank regulators worn down after a year of butting heads over new global capital rules see a glimmer of hope emerging in Washington in the form of Randal Quarles, who’s awaiting confirmation as the U.S. Federal Reserve’s top bank overseer.
With European countries led by France and Germany dug in on one side, and the U.S. on the other, efforts to complete the capital standards known as Basel III have been deadlocked since regulators got close to a deal in Santiago, Chile, late last year. The divisions only deepened after the election of President Donald Trump sowed doubts about the U.S. commitment to global agreements.
The only potential game-changer negotiators see is the arrival of Quarles as the Fed’s vice chairman for supervision, who could prove more flexible than his predecessor in the role, Daniel Tarullo, according to people with knowledge of the talks. Senate Majority Leader Mitch McConnell scheduled a vote Thursday on Quarles’s nomination.
“The stalemate will continue until Quarles is in there, and then the whole thing will restart, presumably with new energy,” said Nicolas Veron, a senior fellow at Brussels-based think tank Bruegel. “The question is if the political stance of the administration makes it impossible for him to agree on a deal. I don’t think that’s the case.”
Negotiators in the Basel Committee on Banking Supervision, who meet Oct. 4-5, are divided over a measure that limits how much lower banks’ estimates of asset risk generated by their own models can go compared with those produced by standard formulas set by regulators. This risk assessment is part of the process for determining a bank’s capital requirements.
European and Japanese regulators, whose banks are avid users of such models, warn that if the measure, known as an output floor, is too high, it will punish banks with low-risk assets. The rival camp led by the Fed says a strict floor is needed to prevent banks from gaming the system. Tarullo was a staunch opponent of internal models.
The Basel Committee brings together regulators from around the world, including the Fed, the European Central Bank, the French and German central banks and Japan’s Financial Services Agency.
While Quarles hasn’t spoken much about Basel recently, his career offers some clues as to how he might approach the talks. At the U.S. Treasury Department from 2001 to 2006, Quarles helped to tackle issues such as a financial-services dialogue with the European Union and the financial-services provisions of six free-trade agreements.
In a 2005 speech, Quarles said that “adherence to the international standards on capital adequacy for banking institutions embodied in the Basel accord” had been “one of the biggest contributors to financial stability.” One year earlier, he said in testimony to Congress that close cooperation as part of the U.S.-EU dialogue could “produce a win-win outcome for the U.S., Europe and the world.”
Such pronouncements feed optimism that Quarles could add fresh impetus to the Basel talks and open the way to an agreement, the people said, asking not to be identified because the deliberations are private. At the very least, installing Quarles as the Fed’s head of supervision will put an end to European complaints over the last year about the lack of an authoritative U.S. negotiator, one of the people said.
And time’s running short. Bundesbank board member Andreas Dombret said on Oct. 3 that a deal is needed before the end of the year or the risk will increase that the talks drag on indefinitely.
“If we go into next year, my doubts would rise, because remember, we are working with end-2015 numbers” in the Basel Committee’s impact assessment of the proposals, he said on Bloomberg TV. “If you go into 2018, I would think that we would need to do more quantitative analysis. So there is a pressure to conclude at the end of this year.”
In May, Basel Committee Chairman Stefan Ingves wrote in a letter to the regulator’s oversight body that most of the finishing touches to the Basel III framework, including revised standardized approaches to measuring asset risk, had been agreed. The “vast majority” of members supported an output floor at 75 percent, he said. Ingves proposed phasing in the floor from 45 percent in 2021 to its final level in 2027.
Bank of France Governor Francois Villeroy de Galhau has said that a 75 percent floor is unacceptable “because it would mean that this floor, and thus the standardized approach, would be the constraint for half of the international banks.” For France, which leads the European opposition together with Germany and the Netherlands, 70 percent is the maximum acceptable floor, the people said.
“There is no U.S. support among the industry or regulators for a low floor, because the U.S. rules will remain gold-plated and any relaxed approach to model discretion exacerbates regulatory-arbitrage opportunities outside the U.S.,” said Karen Shaw Petrou, managing partner at Federal Financial Analytics in Washington. “In sharp contrast to EU banks, U.S. ones must hold the higher of their standardized or advanced weightings, not the lowest one.”
When Quarles went before the Senate back in July, he faced attacks from Democratic lawmakers, who said his past inaction at Treasury before the crisis made him a poor choice for his new role. He responded by acknowledging that he should have been tougher on banks.
“With the benefit of hindsight, we could have been more aggressive,” he said.
— With assistance by John Glover, Haslinda Amin, and Chelsea Mes