Monday, January 7, 2013

What's the Basel Buzz?

The financial press is abuzz this morning with news about a decision to ease the Basel rules regulating international banking. What does this mean? Are we entering a new period of financial deregulation so soon after the financial crisis?

In short, no. The Basel regulation at issue is the Liquidity Coverage Ratio (LCR), which will require banks to hold an adequate buffer of highly liquid assets--basically things like cash and treasuries-- to help them meet unexpected short term needs. In a period of financial distress, a lot of people might want to withdraw their money from the banks, but if the bank has too much money tied up in illiquid assets, then it won't be able to meet this demand for liquidity, and the central bank will have to step in and rescue the bank by acting as lender of last resort.

Banks don't earn much money on the liquid assets they hold, so they would gladly hold less of them and let the central bank come to the rescue when needed. But the central bank and the taxpayers want to keep expensive rescue efforts to a minimum, via regulations that require banks to hold adequate liquidity. Basel tries to harmonize regulations across countries so that a bank can't just move its headquarters to the country with the least strict regulations.

The LCR was set to be fully implemented by 2015. The decision this weekend was to implement it gradually, starting in 2015, but not fully until 2019. The other part of the decision was to count a wider variety of assets as highly liquid. So the news is not that an existing requirement is being loosened, but that a future requirement is being pushed further into the future and slightly loosened. Banks in 2015 and in 2019 will still be more regulated than they are today. Most of the press coverage notes how European bank stocks have surged at the news. Stock prices reflect expected future profits. Since banks will be able to hold less liquid assets from 2015 to 2018 than they would have without this decision, their profits will be higher in those years, so their stock price is higher now. There is also a greater chance that government bailouts may be needed.

The financial crisis inspired a lot of new proposed regulations. Many of them are so controversial that their implementation keeps being delayed. I see regulations set to be implemented several years from now as still subject to revision, and do not count revisions as deregulation.

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