As the Basel Committee on Banking Supervision continues to formulate its Basel III batch of rules, much of the focus has been on two key issues: capital standards and how to designate and regulate systemically important financial institutions. A lengthy implementation timeline for capital standards and a lack of clarity about guidelines for designating SIFIs were topics of discussion at the Milken Institute Global Conference last week.
In the wake of the financial crisis, regulators worldwide began to understand that large, interconnected financial institutions need to be identified and subjected to a different level of regulation. In the U.S., this understanding led to the creation of the Financial Stability Oversight Council, as part of the Dodd-Frank Act. The Basel Committee also is working on the issue and recently devised a formula for determining which firms should be labeled systemically important. Chris Brummer, a senior fellow at the Milken Institute, said the way Basel III and FSOC rules are taking shape leaves room for contradiction on the subject of SIFIs. For example, because the Basel Committee and the FSOC will use different criteria to determine the systemic importance of an institution, it is possible that an institution will receive the designation from Basel but not the FSOC. Translation: An institution could be deemed systemically important to the global financial system but not to the U.S. one.
On the issue of capital standards, Basel III calls for lenders have common equity equal to at least 4.5% of assets, weighted according to risk. Regulators will introduce an additional capital buffer of 2.5% to fend off crises. Banks also will be required to maintain a Tier 1 capital ratio of at least 6%. What instruments constitute “capital” is still under discussion, but banks have years to meet the minimum ratios and until Jan. 1, 2019, to meet the buffer requirement.
The lengthy implementation period for Basel III means the rules might lack relevance by the time they are implemented. Brummer said some institutions are working to comply with Basel III as soon as possible, but others are likely to “run out the clock” and not work to beef up capital until shortly before the 2019 deadline. “There is obviously a risk in that latter scenario,” Brummer said. “By the time they wait, another crisis can occur and we will be talking about Basel IV.”
For more of Brummer’s insight, watch this video.