G20 agenda analysis 3: Basel III banking reform

A tighter belt for banks

This is the third of a four-part series on the G20 Seoul Summit agenda. ― ED.

1. Framework for strong, sustainable, balanced growth (Aug. 13)
2. Reform of the IMF (Aug. 23)
3. Basel III new banking regulations (Sep. 2)
4. Development of poor countries (Sept. 22)

By Cho Jin-seo

Rewind your clock to two years ago and you are at the point where the global financial system was about to explode. A fortnight from now will mark the two year anniversary of the collapse of Lehman Brothers, which filed for bankruptcy protection on September 15th, 2008.

Over the past two years, financial regulators from the G20 nations have endeavored to come up with fundamental changes in the financial sector. The results are to be finalized and announced at the G20 Seoul Summit in November. Dubbed as the Basel III code, the financial regulatory reform has the goal of reducing leverage - making banks safer and bankers less adventurous with their customers’ (and taxpayers’) money.

Apart from measures taken by individual nations, such as the Frank-Dodd Financial Reform Bill in the United States, the G20 initiative has a global reach as it will be endorsed by central banks and financial regulators of all countries involved in the meeting.

The Seoul Summit will rely much on this topic to justify its legitimacy. As organizers are not 100 percent sure whether they will be able to make laudable achievements on other big issues, such as a global growth framework and reforms of international financial institutions. But as for the banking reform, a result is almost guaranteed by the November deadline. The remaining question is its content.

Beyond 8%

The contents are being fine-tuned by the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS). The FSB is a meeting of financial regulators and central banks of the G20 nations. The BSBC is also composed of central banks from major economies. The G20 is supporting them with political pressure from their national leaders.

The most critical issue is how to set the new rules on bank’s capital and liquidity limit and how to prevent banks from becoming too big to fail, among others.

Banks are required to have a certain amount of “core capital” in proportion to their total assets. A 10-percent capital ratio theoretically means that 10 percent of a bank's assets is financed by its stocks and equivalents. Under the current regime, the rule is 8 percent or more for Tier I and Tier II capital. In ordinary times, this is enough because customers do not rush to cash out all at once. But during the financial crisis, it was found that the current standard was not sufficient to prevent a bank run.

The G20 and BSBC want to tighten the standard, by re-defining what counts as “core capital.” The minimum ratio itself will be raised from 8 percent to a higher number, according to Kim Yong-beom, who oversees the reform process at Seoul’s G20 preparation committee.

The BSBC is also going to set new limits on leverage and liquidity. Buffers will be set up between the core and non-core capital, which itself is another regulatory barrier on banks’ excessive leveraging.

‘Don’t call it Basel III’

The changes will be so huge that the banking industry after Seoul Summit will be very different from now, says Kim. “Actually, we do not want to call it Basel III, because it is completely different from the previous ones,” he told The Korea Times. “We are not implementing the new rules based on existing ones. It is virtually a set of whole new rules. We have to ponder the name of the new code.”

For that reason, Shin Je-yoon, deputy finance minister, proposes Seoul I instead of Basel III, though he admits the latter is already settled in the minds of people in the finance industry and the media.

Despite the G20 committee’s determination on banking reform, debate among policymakers and academics are ongoing as to how far the changes should go. One side argues that the stricter the better. The other side, especially bankers themselves, says that too tight limits on capital and liquidity may damage national and global economic growth.

There have been concerns that the banking industry is lobbying regulators in order to dilute the Basel III rules. The Financial Times recently published a full-page article under the title of “Suspense over,” that said the most recent Basel III proposal was evidence of banks winning the lobbying war over hawkish regulators.

Kim of Seoul’s G20 committee disagrees.

“It will be a shock to bankers anyway. There will be a shift of philosophy in the regulatory codes from principle-based to rule-based. It will be soul-searching for the banking industry,” he said.

Capital and liquidity standards, of course, are not everything in banking regulatory reform. There are more politically sensitive issues such as putting a limit on bankers’ bonuses, making credit-rating agencies more independent from firms they rate, and establishing a public exchange and central clearance system for complex derivatives products, which have been mostly traded over-the-counter.

But those issues are mostly the big concerns of a few western countries, and have been dealt with enough at previous G20 summits, said Kim. So the Seoul Summit’s highlight will be the unveiling of the new capital and liquidity regulations of Basel III, or Seoul I, depending on how you want to call it.