Basel III – the regulators strike back!

Andrew Pegler – 17 September 2010

For the years leading up to the financial crisis banks across the world had been progressively thinning out how much money they had up their sleeves for the day things turned ugly. As we know that ended predictably but last week the regulators finally struck back.

This stash, known as reserves, is supposed to be pretty heavily policed but pre GFC things were good so no one was really watching. Then the punch ran out, the cops turned off the music, the party stopped and the hangover started and banks everywhere went into meltdown with little in reserve to absorb mounting losses. A response was needed and a room full of bankers in Switzerland called the Basel Committee have delivered it in the form of tough new reserve regulations for banks.

Known as Basel III, the recommendations include doubling the amount of equity capital (the best kind) a bank must hold in reserve from 2% to 4.5% and an extra reserve of 2.5% of their assets called a “conservation buffer”. This buffer can be reduced or increased depending on the economy i.e. rise up to 2.5% if credit is too loose and drop if the economy is tightening. All this means that banks will now have to keep 7% of their equity in reserve in case the wheels come off again. And that’s about double what they had to hold before.

But wait, there’s more! The Basel Committee also added an optional third reserve figure of 2.5% of assets called “countercyclical buffer”. So if credit is expanding faster than GDP, bank regulators can up the reserve requirements to slow credit bubbles and strengthen the banks. Vice versa in a credit crisis – regulators can abolish the buffers immediately and set capitalism free. Nice.

My view? In the glacial-paced world of banking regulations the Basel Committee has done good/played hard. The banking system will be more resilient to larger shocks, less reliant on government support and better able to absorb losses. But let’s not forget this crisis was not about banks missing 1% or 2% of capital. It was about uncontrolled lending that went viral and undetected until it was too late. And then there’s the TBTF (“too big to fail”) problem that none of this addresses. Oh and not having all this coming into effect until 2019 is too long in this fast-paced financial age.

And in other news… Legendary US investor Warren Buffett has ruled out a double-dip recession in America. Da man with the golden touch, the oracle, the seer, the doer. “I am a huge bull on this country,” says Warren. “We will not have a double dip recession at all. I see our businesses coming back almost across the board.” Da Buff has spoken in da buff.