Global bank regulators should scrap Basel capital rules and go back to using a straight-forward leverage ratio to reduce risk in the financial system, Federal Deposit Insurance Corp. board member Thomas Hoenig said.
The Basel Committee on Banking Supervision, which brings together regulators from 27 countries including the FDIC and three other U.S. agencies, revised global capital rules in 2010. The new regulations, which go into effect next year, will tighten the definition of what counts as capital, increase banks’ minimum ratios and tighten how risk is defined in calculating those ratios.
The Basel rules have come under attack for increased complexity and allowing banks to game the system by playing with their risk models. Since 2004, the framework has allowed the largest banks to rely on proprietary models to determine how risky their assets are and how much capital they need. The 2010 revisions didn’t change that risk-weighting method. A simple leverage ratio would measure equity versus total assets, ignoring whether they’re risky or safe.
“The committee should agree to delay implementation and revisit the proposal,” Hoenig said in a speech prepared for delivery today in Arlington, Virginia. “Absent that, the United States should not implement Basel III, but reject the Basel approach to capital and go back to the basics.”
Former FDIC Chairman Sheila Bair has been critical of Basel’s reliance on bank risk models and was instrumental in introducing a simple leverage ratio in 2010. European regulators, who agreed to add that benchmark during Basel negotiations, have since balked at implementation since doing so would require their banks to raise additional capital at a time when they’re struggling with a sovereign-debt crisis.
Basel III raised the minimum capital requirement to almost 9 percent for the largest institutions on a risk-weighted basis. Using that measure, Bank of America Corp.’s capital ratio was 11.2 percent at June 30, according to its regulatory filings. Ignoring risk levels, the ratio dropped to 7.8 percent.
A simple rule based on the ratio of tangible equity to tangible assets would be the best way to ensure safety and soundness as it would further narrow the definition of capital, Hoenig said. As of June 30, tangible equity for the 10 largest U.S. banks was only 60 percent of what counted as common equity capital under Basel rules, Hoenig said. Depending on the bank, a tangible leverage ratio of 10 percent might be reasonable, he said.
“Where the markets assess, demand and adjust intrinsic risk weights on a daily basis, regulators using Basel look backward and never catch up,” Hoenig said. “People knew well in advance of the recent financial crisis that the risk on home mortgages had increased during the period between 2005 and 2007, yet no changes were made to the risk weights.”
Andy Haldane, Bank of England’s executive director for financial stability, said last month the rules may be too complicated to provide the oversight needed to prevent another crisis.
The push for risk-sensitivity in Basel III has “spawned startling degrees of complexity and an over-reliance on probably unreliable models,” said Haldane, who also advocated use of simple leverage ratios instead.