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25 January 2013

We're a Long Way from Bedford Falls Banking

Wayne Abernathy of the American Bankers Association recently wrote that Basel capital rules would 'contract bank services' and that they are 'seriously out of touch' with U.S. laws, customs and economic conditions. But many of his arguments are based on myth, not fact.

This commentary originally appeared on American Banker.

Having been brought up in McAllen, Texas, a U.S-Mexico border town, traveling to a foreign country has always been second nature for me. As such, I am always attracted to articles or books where significant global issues are explored.

When I began to read "What I Learned from a South African Banker," by Wayne Abernathy of the American Bankers Association (American Banker, Jan. 15, 2013), I found a thought-provoking piece looking at Basel III from a global perspective.

The Basel III rules were created following the 2008 financial crisis, which originated in the U.S. and impacted the U.K. and continental Europe. These countries, in turn, served as major influential forces during the rule-writing process, and Abernathy is correct to point out that the new rules are often ill-suited and even unfair for many emerging markets and for smaller banks worldwide.

However, in the fourth paragraph, I came across some of the usual myths about Basel and banking. According to Abernathy, the South African banker in question said new capital rules would contract bank services. But bank services like what? Lending, which is or should be the main role of a bank? Where is the proof of this? Capital rules, generally, are meant for banks to be able to withstand unexpected losses due to a stress situation so they do not pose a systemic risk to their country and across the globe.

The Basel framework is not about managing by numbers. In meeting Basel III requirements, banks have to rethink their risk management strategies; that is, how they identify, measure, control and monitor their risks. They do not have to stop lending, an oft-repeated industry mantra. If a bank finds that it does not have enough real loss absorbing capital, it must curtail its risks, i.e., deleverage or raise equity in the market.

Banks can divest from their investments in hedge funds, private equity, commodities or derivatives for speculative purposes. Particularly since 2008, U.S. and European banks have had plenty of government assistance in the form of bailouts. Monetary authorities have injected liquidity a plenty, bringing interest rates to historic lows. And banks still say/threaten that they cannot lend.

Secondly, Abernathy states: "The idea that bankers must manage their liquidity positions is a good one. The idea that a college of experts in Switzerland can tell bankers around the world how to do it is unreasonable, and dangerous." Given his professional experience, Abernathy knows exactly what the Basel committee is, but his wording makes the committee sound – my goodness – foreign and academic.

It is extremely important to remember the U.S. and U.K. originated the Basel framework in the early 1970s. Over four decades, as the global economy and financial sectors changed, Basel committee membership grew to 27 countries. This growth explains why so much debate and compromise is inevitable. It also, at times, explains why original proposed rules end up watered down.

Additionally, the "college of experts" Abernathy refers to technically cannot tell any banker what to do. What the Basel committee releases in the form of accords are guidelines. Each member country must then take that framework back to its government for review; hence there are often differences in what components of and how a country implements Basel.

Abernathy also refers to the "liquid" status of Greek sovereign debt "under earlier Basel drafts." He is absolutely right to question the reliance on anyone's sovereign debt as creditworthy or liquid, including in so-called developed markets such as the U.S., U.K., Spain, Italy, France, etc. Yet, earlier Basel accords did not have any guidance for liquidity. That's why the Basel committee included liquidity standards in its 2010 Basel III accord.

On January 6, the Basel committee released a final liquidity coverage ratio, which, while a historic accomplishment, was much more watered down than originally proposed in 2009. The net stable funding ratio will probably be finalized later this year.

[Related: "The Weakening of Basel III" (video)]

Abernathy states the Basel rules "are seriously out of touch with the laws, customs and economic conditions in the U.S." Nothing could be further from the truth. Why does Basel III now have guidance on leverage, liquidity, SIFIs, mortgage-backed and other asset-backed securitized products in the trading book? The items are very much related to the global financial crisis caused and exported by big banks in the U.S. If he had been referring to small or community banks, then it would be fair to say that Basel III was not created for them.

Abernathy goes on to critique the "Basel liquidity plan" because it "assumes that banks will lose significant amounts of deposits when the economy becomes shaky, but U.S. banks actually gained deposits during the recession." Yes, deposits increased in the U.S. because investors moved out of equities and bonds into deposits. Yet, depositors could have just as easily fled.

Finally, Abernathy states that amongst the bankers he has known, "There is a common theme that draws them to a banking career: the desire to be part of economic growth, to be part of the job that banks do of bringing savings and investment together to build local and national economies."

This statement conjures George Bailey of "It's a Wonderful Life" trying to save the Building and Loan in Bedford Falls, but it's been a long time since that's what systematically important banks were about. The reason Basel III has become so much more detailed is because banks have become bigger, more complex, and more connected to the global economy.

Until shareholders heighten risk management practices and hold bank management accountable, bank regulatory frameworks, even imperfect ones, will be critical in trying to minimize the contagion that badly-managed banks can inflict on you and me.

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