The first Basel agreement on global banking regulation, adopted in 1988, was 30 pages long and relied on simple arithmetic. The latest update, known as Basel III, runs to 509 pages and includes 78 calculus equations.
The complexity is emblematic of what happened over the past four years as governments that injected $600 billion to rescue failing banks during the worst financial crisis since the Great Depression devised ways to make the global banking system safer. Those efforts have been stymied by conflicting laws, divergent accounting standards and clashing rules adopted by nations to protect their interests, all of which have created new risks.
Moving derivatives trading to clearinghouses may concentrate risk and make those marketplaces too big to fail, requiring government rescues. Rules named after former Federal Reserve Chairman Paul A. Volcker and former Bank of England Chief Economist John Vickers may not succeed in curbing risk. U.S. regulators are still debating where to draw the hard-to-see line between trading and making markets for clients as required by the Volcker rule. Volcker himself has questioned the effectiveness of Vickers’s proposal to insulate trading units.
The Fed last month proposed that foreign lenders organize their U.S. units as subsidiaries and hold capital independently from their parent firms to make it easier for U.S. regulators to seize local assets in a crisis.
Countries made further changes as they translated the non-binding Basel rules into regulations and laws. The European Commission has sought to soften the definition of capital even more, allowing banks to count as capital some hybrid securities Basel had eliminated. The commission, the 27-nation EU’s executive arm, also omitted from its rules a simpler version of the leverage limit agreed to in Basel. That constraint ignores the risk-weightings used in calculating capital and is based instead on total assets, a tougher standard.
“Banks will always find loopholes to get around these rules, especially if they’re so complicated,” said Mark Adelson, chief strategy officer at BondFactor Co., a municipal bond-insurance firm, and a former Standard & Poor’s chief credit officer. “With all those formulas, they’re like physics books. How can anyone monitor compliance with such complexity?”
Today, those formulas allow JPMorgan Chase & Co., the biggest U.S. bank, to say that only half of its balance sheet is risky, regulatory filings show. Deutsche Bank AG, Germany’s largest lender, calculates its risk to be 17 percent of assets.
More capital can never make the system safe because it doesn’t prevent banks from taking risk, according to BCM’s Matthews. Having a cross-border mechanism for shuttering failed global banks in a way that doesn’t jeopardize other firms is the only way to safety, she said. Such a plan will work only if the countries with the biggest financial markets pledge to share costs of a blowup, not just pay lip service to cooperation.