The Skinny on Basel III

The year was 1974. A number of German banks hit some snafus with their dollar payments to New York, exposing them to a considerable amount of credit risk. To deal with this situation, a league of extraordinary gentlemen (no, not the one headed by Sean Connery, although he is indeed extraordinary) from the G10 nations stepped up and formed the Basel Committee for Banking Supervision in Basel, Switzerland.

In order to prevent banking mishaps from happening again, the Basel Committee came up with a set of standards for the banks of their member nations. The first set of guidelines, known as Basel I, set a minimum capital requirement for banks to hold in their vaults. Basel II, which was an upgrade of Basel I, comprised banking laws and regulations that protect against financial risk.

Around 2005, the committee made several revisions and updates on Basel II and the new version was called Basel III. Then, they added a bunch of cool features, such as multi-tasking and local notifications, and came up with iPhone 4. Oops, got sidetracked there…

Fast forward to 2010. Just as the Fellowship of the Ring joined forces for the third time in “The Return of the King,” central bank chiefs all around the world have come together again to lay down the law for banks worldwide. They recently came to an agreement on Basel III and have decided to tighten capital requirements for the banking industry.

In an attempt to lower risk and prevent too much debt, the latest updates to the Basel Accords will require banks to maintain top-quality capital of at least 6% of their risk-bearing assets, up from 2% prior to the financial meltdown. In less nerdy terms, this means they’ll have to keep more money in stock as a safety buffer in case the industry gets hit by unexpected financial blows. Gotta get more cushion for the pushin’!

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Naturally, there have been a few objections to the new rules. Some argue that it will cut into banks’ profits, as they will be forced to cut back on their lending practices. In response to this, officials are willing to give banks about five years to comply with the basic ratio requirements so as not to hurt them so much. That’s mighty thoughtful of them if you ask me.

Of course, having “safer” banks comes at a price. Some argue that the new agreement could be detrimental to smaller banks, as they would have more difficulty in meeting the reserve requirements. In the process of raising capital requirements, banks will be forced to increase the cost of credit, which could be bad for those looking to borrow money in the near future. Small businesses will suffer and economic growth could take a hit.

On the other hand, some analysts believe that the opposite could occur. Apparently, some banks had actually restricted lending and saved up in anticipation of tighter regulations than the ones that were agreed upon. This could mean that lending will pick up in the coming months.

It appears that the markets reacted positively to these new developments, as higher-yielding currencies came out in force yesterday. EURUSD rose 150 pips from its opening price, almost touching the 1.2900 handle. Meanwhile, the comdolls had a party last night, getting wasted on their pip and soda, as they all posted decent gains.

I do believe that these new regulations are a step in the right direction. Clearly, we have seen what disastrous effects having too lenient rules can lead to. More transparency and stricter rules are the way to go if you ask me. Hopefully, we can get more and more banks to jump on the bandwagon and get these rules in place as quickly as possible.

  • basel III

    Only
    by wisely and decisively governing the creation of credit may a great
    transformation of capitalism be achieved – and only then may the global economy
    chart a new direction, towards green and socially inclusive economic growth and
    prosperity.

  • George Lekatis

    Only the dead have seen the end of war. Plato

    There is no way to zero risk in banking, this is for sure.
    Basel iii is not perfect, but it is better than Basel ii.

    The framework improves consistency and establishes risk
    management principles that are unique.

    Yes, we will have another crisis in the future, this is also
    for sure. It is simple: Passing laws against robbery and murder has not stopped
    people from robbing and murdering.

    To ban or not to ban taking risks? More strict banking rules
    can destroy the economy. Banks will not be willing to lend. What is next?
    Unemployment, bankruptcies, no mortgages…

    Banks are (and must be) in the business of taking risks. Sometimes
    governments force banks to lend to at-risk borrowers, and decisions are based
    on government intervention, not risk management. Is there a framework against
    that? Can we blame Basel iii?

    We can increase the likelihood that banks can absorb losses
    under certain circumstances. This is all we can do.

    George Lekatis

    http://www.basel-iii-associati