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’!
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.