Making a bank Basel III compliant is only a start. It’s the risks that Basel doesn’t address that are the stuff of nightmares, writes Brian Caplen.

The Basel rules failed to prevent the last crisis and they are unlikely to prevent the next one. Of course, it makes sense to insist that banks have sufficient capital, are not overleveraged and have sufficient liquid assets as the Basel III aims to do.

But the origins of crises are diverse and many are outside the scope of the Basel Committee. They are often political in nature and so would require political consensus to address them, something that cannot be depended upon. Prudent banks are ones that do their scenario planning with this in mind rather than just ticking the Basel boxes.  

At a recent meeting of the Centre for the Study of Financial Innovation in London, banking experts put forward a number of hard-to-solve problems for Basel. There were even doubts expressed about the long-term relevance of Basel in a multi-polar world in which China may prefer to go its own way and the US is currently disengaged from multilateral initiatives.

But assuming that Basel stays centre stage in bank rule-setting, it will still ​struggle to solve political issues such as the risks of banks having large holdings of sovereign bonds and how this plays out if the sovereign gets into trouble. The committee has reviewed this area but was unable to agree on any changes to the treatment of sovereign bonds.

The new standards for resolution regimes were developed by the Financial Stability Board with the aim of preventing tax payer-funded bail-outs. But the decision as to whether to save a troubled bank or let it go will always be a political one in the final analysis.

Then, there are the unintended consequences of the new rules and policies that have been put in place since the last crisis. Quantitative easing has led to a mispricing of risk and a decline in net interest margins while the tighter rules on proprietary trading have deprived banks of their market-making role, leading to fears of liquidity drying up in times of stress.  

Finally, there are the many issues raised by new technology. These also have a bearing on liquidity, as well as creating challenges at the core of the banking model and introducing new risks such as those of a cyber attack. Outsourcing operations to the cloud raises further security issues.

Complying with Basel is only a first step for banks in their prudential planning. It’s the risks that are outside the scope of Basel that must also hold bankers’ attention.

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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Bill Coen, secretary-general of the Basel Committee on Banking Supervision, responds:

Dear Mr Caplen

I am in complete agreement with the sentiment expressed in your editor’s blog. Compliance with Basel’s minimum requirements is a good starting point for helping ensure the resilience of banks and banking systems but this is just one (important) factor among many. These other factors include capital commensurate with a bank’s risk profile rather than sole reliance on Basel minimum requirements; effective (even intrusive) bank supervision; market discipline exerted by analysts, large investors, banks’ counterparties and other market participants that is informed by timely and relevant bank disclosure; and, of course, strong risk management, sound corporate governance and appropriate culture. In addition to these essential elements, another critical step to help ensure – as you say – “that banks have sufficient capital, are not overleveraged and have sufficient liquid assets” is for the Basel III rules to actually be implemented when and in the manner agreed.

All of these elements – including doing what we can to help ensure full, timely and consistent implementation of the agreed upon Basel standards – are prominent themes of the Basel Committee’s work programme. This is a point I have been pressing and I will continue to stress: Adoption of and adherence to sound regulatory standards are preconditions to financial stability but are irrelevant if not accompanied by those other factors.

Bill Coen

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