Friday, January 4, 2013

Germany calls on US to adopt Basel III

As reported by Reuters, Germany is calling on the US to stand by its commitment to adopt Basel III capital requirements for its banks.

Regular readers know that Basel III is the classic example of regulatory failure.

First, bank asset values are meaningless due to the suspension of mark-to-market accounting, regulatory forbearance that lets banks engage in 'extend and pretend' and create 'zombie loans', and its heavy reliance on bank internal valuation models.

When asset values are meaningless, so too is the accounting construct known as book equity, the largest component of bank capital.

Dividing two meaningless numbers, book capital and risk-weighted assets, by each other does not produce a meaningful number.  A point driven home by the OECD.

Second, by acting like bank book capital levels are meaningful, regulators are effectively encouraging banks not to lend.  Lending takes lots of capital.  Betting using derivatives and government debt takes very little capital.

Third, Basel III is hopelessly complex.  The Bank of England's Andrew Haldane observed that it could not be calculated on the back of a standard business envelope.  Rather, it takes a computer and too many assumptions to make it remotely meaningful.

In short, there is not one redeeming element to Basel III unless your goal is to preserve opacity in the financial system and let the big banks continue to take risk.

German Finance Minister Wolfgang Schaeuble urged the United States to stand by its political decision for tougher bank capital rules and said he was confident Europe would complete the necessary details this year. 
"I am confident that in the course of the year we will complete (the details) in time to be able to start building up the additional capital required in the timeframe set by Basel III," Schaeuble wrote in an essay seen by Reuters on Thursday. 
"I also expect from our American partners that they too stick firmly to the political decision to introduce the new set of rules," he added. 
Major financial centers like the United States and the European Union are delaying the start of the world's main regulatory response to the 2007-09 financial crisis, which requires banks to triple their basic capital buffers in stages.
It is an incredibly sad statement that the world's main regulatory response to the 2007-present financial crisis is Basel III.

Were Basel III in place today, market participants could still not determine which banks are solvent and which are not.  This is important, because without this ability, the interbank lending market never unfreezes and banks can never be weaned off of all the government programs put in place since the beginning of the financial crisis.

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