This looked bracing from the Basel Committee for Banking Supervision on Friday: proposals for a counter-cyclical capital buffer for banks.
But there’s a bit less than meets the eye.
Here’s some Basel jargon introducing the buffer, from the consultation paper:
The countercyclical buffer proposal set out in this document is designed to ensure that banking sector capital requirements take account of the macro-financial environment in which banks operate. It should be viewed as an important internationally consistent instrument in the suite of macroprudential tools at the disposal of national authorities. It should be deployed when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses.
Macro-prudence — nice. Lots of discretion for national regulators? Not so sure about that one:
The countercyclical capital buffer will work by giving each jurisdiction the ability to use their judgement to extend the size of the minimum buffer range established by the capital conservation buffer…
Internationally active banks will look at the geographic location of their credit exposures and calculate their buffer add-on for each exposure on the basis of the buffer in effect in the jurisdiction in which the exposure is located. At an enterprise-wide consolidated level this means that each bank’s buffer will effectively be equal to a weighted average of the add-ons applied in jurisdictions to which they have exposures.
Sounds awfully complex to achieve in an era of bank internationalisation, particularly since the onus will be on home regulators to make banks calculate their host buffers, according to the proposal. This bit especially sounds like a big ask:
As part of prudent management of country risks banks should already have the necessary data on the geographic breakdown of credit exposures. Furthermore, information on domestic exposures is routinely provided through regulatory returns filed with domestic authorities, and information on foreign exposures on an ultimate risk basis is available at an aggregate level through the Bank for International Settlements international banking statistics…
BIS banking statistics shouldn’t be taken at face value, as we’ve noted over the question of who’s been most exposed to peripheral European sovereign debt in recent months.
Plus:
In addition, authorities will also need to be vigilant and ensure that their banks diligently look through structured product and other risk-transfer vehicles to the geographic residency of the underlying assets or obligors.
Are regulators up to this?
All this for a buffer decision that the Committee expects to be made about every ten or twenty years per regulator, including a year’s warning for banks to finish building up capital. Which latter idea is actually quite clever — a long warning period could nip incipient lending booms in the bud before they get too bad, for instance.
But the thorniest question here is how to define ‘excess aggregate credit growth’ from banking system to banking system. Or, in the paper’s jargon-speak:
…the countercyclical capital buffer proposal uses a common starting reference guide for buffer decisions… while historically the credit/GDP gap would often have been a useful guide in taking buffer decisions, it does not always work well in all jurisdictions at all times. Judgment coupled with proper communications is thus an integral part of the proposal. Rather than rely mechanistically on the credit/GDP guide, authorities are expected to apply judgment in the setting of the buffer in their jurisdiction after using the best information available to gauge the build-up of system-wide risk.
Interestingly, some suggested alternative reference points are CDS and bank funding spreads, such as the TED spread, which the Committee says captured the warning signs over the 2008 crisis. But only that crisis, so far.
There’s plenty in the paper for bankers to discuss before consultation ends in September, then. And it’s a good case study for the limitations of Basel.
In short: a complex rule cut to the crazy-quilt cloth of financial globalisation, to be implemented roughly once every geological epoch and with uncertain ultimate impact on the real economy.
The story of Basel III’s life, we guess.
Related links:
Progress on regulatory reform package – Basel Committee
Bish, bosh, Basel – Deus Ex Macchiato
All hail the Basel banking regime change – FT Alphaville
Basel letters page – FT Alphaville