Not a day goes by in the financial services industry where “Basel” rules aren’t mentioned.
The proposed rules from international banking regulators are intended to make banks safer and prevent another financial crisis requiring bailouts with taxpayers’ money, as happened in 2008. These sweeping reforms for banks across the world are on the cusp of being finalized — but banks don’t like them.
Somewhat surprisingly, neither does Brussels.
EU politicians have very publicly denounced proposals from the Basel Committee on Banking Supervision, named after the Swiss city where it’s based, claiming banks in the bloc would be put at a competitive disadvantage if the proposed rules are enforced in their current form.
That could in turn harm lending to European businesses and households, critics claim. The EU’s finance ministers met as recently as Tuesday to discuss their concerns, and parliamentarians questioned the Basel Committee’s secretary-general in a meeting Wednesday.
The U.S. is more supportive of the rules — leading some to charge that the process is being led by U.S. banking interests.
With just six weeks to go before a meeting to finalize the proposals is held in Santiago, Chile, time is ticking for the EU, U.S. and other Basel Committee members to reach a compromise.
But what exactly is Basel, and if you’re not running a bank why should you care?
1. What’s Basel — and why is it in the headlines?
The Basel Committee — or just Basel — is a global banking regulator. It sits in a tall, gray, cylindrical building in the northwest of Switzerland along with the Bank for International Settlements, which is composed of 60 central banks from around the world.
Basel has 27 member countries, plus the EU. It was established in 1974 and has been making rules for banks since its first Basel Accord in 1988. It answers to an oversight body chaired by Mario Draghi, the president of the European Central Bank.
Its latest set of proposed rules, known as Basel III, has been in the pipeline since immediately following the 2008 global financial crisis. Despite being known to banks and regulators for a while, they have recently become the subject of an international political spat in the lead-up to the Basel III round’s final meeting in Chile on November 28 and 29.
2. What’s Basel doing?
The Basel Committee wants its member countries to apply a number of diverse rules with two aims: Prevent banks from failing and manage the fallout if they do. Basel III was launched in two separate initiatives, in 2010 and again in 2014. Both involve strengthening how much money banks should have with their own, un-borrowed funds, to cover all kinds of risks from lending to fraud — known as capital requirements.
In addition, the second wave affects how banks calculate the amount of money they need to cover those risks. This is what seems to have most upset the EU.
The biggest banks now use their own in-house models — sophisticated calculations that assess specific factors such as the client’s likelihood of going bust. The Basel Committee wants to curb the use of those models, as it says they’re too complex and banks could game them.
3. What’s ‘Basel IV?’
“Basel IV” is how detractor banks describe the second wave of proposals, as these came later and somewhat unexpectedly, unlike the Basel III draft rules. Its very mention riles regulators, though, who say it’s all part of the same package. Earlier this year, Bank of England chief Mark Carney slammed it as an “ugly rumor.”
Regardless of their names, the proposed rules should bolster the way banks assess risks. But this stricter risk management could increase the money the institutions need in case their customers can’t pay them back.
4. But isn’t that a good thing?
Depends on who you ask. Banks argue the cost of funding steeper capital requirements — which one industry association has calculated to be an additional €859 billion for EU banks — means they won’t be able to lend as much as they otherwise could to households and businesses. European banks have warned that they’ll have to either retreat from lending or face increasing costs. And the European Commission, Parliament and EU member countries are all on their side.
Other Basel Committee members (namely, the U.S.) and its secretariat, conversely, have stood firm on their belief that better-capitalized banks equal more resilient banks, therefore making them more likely to lend even in severe economic downturns.
5. How will all of this affect me personally?
If the new rules have the effects EU banks claim they will, they could have a genuine impact on everyday life. Mortgages and other loans could become more expensive, and transport companies, for example, have said the proposals as they stand will make improving Europe’s rail networks more costly. In such a scenario, the higher costs for rail companies will very likely be passed on to the traveler.
But if proponents of the rules are correct, it’ll mean safer banks that are less likely to fail and more likely to lend to fund economic activities.
6. Why are US banks not as worried?
Banks operate very differently in the EU compared to across the Atlantic. Businesses are more reliant on bank funding in the EU, and mortgage risk remains banks’ responsibility here, while they are guaranteed by public agencies in the U.S.
All of that makes for more potential risks on the balance sheet of European banks, which could mean they must maintain higher capital cushions.
7. What happens if countries don’t reach a compromise?
They could just carry on negotiating final rules as the end-of-year deadline is self-imposed. But the Basel Committee has long stated that it wants to finalize the rules by the end of 2016 and insists it’s still on track for that date.
When the rules are finalized, however, they won’t immediately affect banks. That’s because the Basel Committee issues guidelines, rather than legally binding legislation. It relies on its members to write rules into their own law, meaning if the EU remains unhappy it could just ignore what it doesn’t like.
There are consequences to such defiance. The Basel Committee reserves the right to grade its members’ implementation of its rules and in 2014 it assigned the EU the worst possible score.
It’s more of a slap on the wrist than anything else, but if ratings agencies such as Moody’s or S&P take note, they could downgrade the EU. That will also directly affect European banks’ business and could increase the cost of banking for their customers.
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