When THE BASEL III FRAMEWORK was finalized in December 2017, it represented an important milestone for the post-crisis movement to reform and strengthen financial regulation. Yet, in parallel with these global efforts steered by the Basel Committee, many jurisdictions have introduced additional measures, including more-conservative prudential requirements and bank structural reforms, such as ring-fencing. What impact do these measures have on the global regulatory framework for banks, and what are the implications for international cooperation? Do they complement the Basel III framework, with both sets of measures mutually reinforcing bank prudential safeguards? Or are there areas of tension that could weaken the Committee’s mandate of enhancing global financial stability? In this article, I look at the role of prudential minimum standards for global banks in providing the basis for national laws, rules, and regulations.
From Global to Local
Broadly speaking, the post-crisis bank reform agenda has focused on three main dimensions:
- Strengthening the regulation and supervisory oversight of banks
- Developing a toolkit to resolve failed banks in a timely and orderly manner
- Insulating certain banking activities through structural ring-fencing
These measures were generally developed in parallel with Basel III but vary in terms of their scope of application. For example, in the case of the regulatory framework, the Basel III framework is a global minimum standard for internationally active banks. It seeks to ensure a level playing field across all jurisdictions for global banks. If individual jurisdictions were to adopt national regulations that are less stringent than the Basel standards, these could prove unsafe and unsound in the long term, undermining the resilience of banks and the financial system. In contrast, many jurisdictions can – and often do – apply more-conservative requirements than those set out in the Basel framework.
Certain other international initiatives relate to the resolution of troubled banks. For example, the Financial Stability Board has adopted guidance on effective resolution regimes for financial institutions, and it has set total loss-absorbing capacity standards. These global agreements apply mostly to global systemically important banks. But they are complemented by a wide range of domestic and regional measures.
Finally, a number of structural reforms aim at what is sometimes referred to as ring-fencing. These constitute a fairly broad set of measures, including both geographic ring-fencing (requiring capital or liquidity resources of a global bank to be held at a jurisdictional or regional level) and functional ring-fencing (requiring that certain types of activity are segregated or prohibited within a banking group). Unlike the global frameworks, these initiatives have been adopted at the jurisdictional or regional level.
Why have these measures been put in place at different levels? What impact, if any, does this have on international cooperation and global financial stability? And what does it mean for the work of the Basel Committee?
When assessing the role of global standards in forming the basis for national or regional laws, directives, rules, and regulations, one must remain mindful of the context. (Note: Laws, directives, rules, and regulations refer to the legally binding requirements adopted by a country or jurisdiction and are distinct from the nonbinding nature of “standards.” For the sake of brevity, “regulations” is used here but should be understood to refer to a jurisdiction’s laws, directives, regulations, etc.)
Any discussion about the impact of regulation must start with a look at the costs and benefits. The evidence to date shows that any Basel III regulatory costs are easily outweighed by the benefits. For example, a Basel Committee 2010 study, “An Assessment of the Long-Term Economic Impact of Stronger Capital and Liquidity Requirements,” found that clear long-term economic benefits will accrue from increasing minimum capital and liquidity requirements. These benefits consist of making financial crises less likely and reducing the associated output losses. Experience since 2010 suggests that the actual net benefits have been even larger than expected.
Another important contextual factor is the distinction between global minimum standards and a jurisdiction’s regulations. The Basel Committee sets global standards for bank regulation and supervision. It also issues guidelines and promotes sound practices. It has no formal supranational authority, however. Its decisions have no legal force. Rather, the Committee’s members are responsible for transposing the agreed-upon standards into binding laws and regulations.
“Gold Plating” – Compliment or Pejorative?
The Basel standards represent global minimum standards.
National arrangements – such as ring-fencing schemes, stress-testing frameworks, deposit insurance guarantees, and resolution regimes – supplement or complement the global standards. The implementation of such measures is consistent with the Basel Committee’s philosophy that national circumstances may speak for the adoption of additional national regulations, or ones that exceed the global minimum standards. From the global perspective, such “gold plating” is warranted – even welcome and expected – in light of the wide variety of national supervisory powers and practices among Basel Committee members, to say nothing of their differing legal environments; resolution and insolvency regimes; financial and business cycles; fiscal policies; and degree of economic development.
But such gold plating has set off a lively debate, particularly about its supposedly damaging effects. For instance, some allege that national ring-fencing results in “trapped” capital or liquidity at the local level. But this ignores the obligation of national supervisors to apply national regulations to firms doing business in their jurisdiction and their supervisory duty to maintain the safety and soundness of their banks and banking system. It also overlooks the mechanisms for cooperation built into the international regulatory architecture, such as supervisory colleges and crisis management groups.
In the run-up to the completion of the Basel framework in December 2017, a common refrain was the need to maintain risk sensitivity. There was a concern – misguided, in my view – that the imposition of an output floor and the other measures might impair the framework’s risk sensitivity. The Committee supports a risk-weighted capital regime, which should remain at the core of the framework for banks, as complemented by the leverage ratio and liquidity metrics. At the same time, the pursuit of increased risk sensitivity considerably increases the complexity of the capital adequacy framework in some areas – particularly the calculation methodology for risk-weighted assets. Simply put: One cannot and should not relentlessly pursue risk sensitivity as a goal in itself; it must be balanced with simplicity and comparability. Similarly, one cannot expect national supervisors and regulators to abandon established national regulations in pursuit of a common global framework that does not allow for the exercise of discretion in response to national circumstances – as long as those national measures meet or exceed the globally agreed-upon minimum standards.
The desirability of having a single set of harmonized global standards is understandable, especially for large, internationally active banks conducting business worldwide. Although the prospects of adopting a uniform global legal framework and harmonized supervisory powers and practices are highly improbable, the revised Basel framework provides a common foundation. Combined with a vastly improved set of Pillar 3 disclosure requirements, investors, counterparties, and other market participants can make like-for-like comparisons of banks, thereby helping to instill market discipline.
Better Supervisory and Regulatory Cooperation
The revised Basel minimum standards have addressed flaws that were exposed by the global financial crisis. When implemented at the national level, they will also help reduce variability in the reported results produced by banks’ internal models. Disclosure requirements will also improve the global framework for large internationally active banks. Last but not least, better supervisory and regulatory cooperation will also contribute to leveling the playing field.
For many, the promotion of global standards for the regulation and supervision of banks is the Basel Committee’s defining role. Such standards include the Basel capital and liquidity frameworks, the “Core Principles for Effective Banking Supervision,” and the large exposures regime. Yet an equally important part of our work focuses on promoting communication between supervisors by doing the following:
- Exchanging information on the banking sector and financial markets to help identify current or emerging risks to the global financial system
- Sharing experience on supervisory issues, approaches, and techniques to promote a common understanding and improve cross-border cooperation
- Addressing regulatory and supervisory gaps that endanger financial stability
- Monitoring the implementation of the Basel standards in member countries and beyond to encourage their timely, consistent, and effective implementation
- Consulting with nonmember central banks and bank supervisory authorities to benefit from their input into the Committee’s policy formulation process and to promote the implementation of its standards, guidelines, and sound practices beyond its member countries
- Coordinating and cooperating with other financial sector standard setters and international bodies, particularly those involved in promoting financial stability
Communication, coordination, cooperation, and consultation: Collectively, these have been the Basel Committee’s raison d’être since 1974, the year it was founded. For example, one of the Committee’s earliest guidelines, known as the “Concordat,” was published in 1975 and sets out principles for sharing supervisory responsibility for home and host supervisors on banks’ cross-border establishments. The Committee continues to focus on these activities today. The importance of these four “Cs” was never more apparent or necessary than during the global financial crisis, when potentially disastrous episodes unfolded one after another – at times, almost minute by minute. The ability for the authorities to interact, share information, and keep abreast of developments was crucial then and remains so today.
As the global financial system is intricately interconnected, so, by necessity, are its regulation, supervision, and oversight. International communication, coordination, cooperation, and consultation among authorities have improved dramatically since the crisis. Some of the measures include the Committee’s expanded membership and the creation of its Basel Consultative Group; the adoption and promotion of “supervisory colleges”; and the regular International Conference of Banking Supervisors (ICBS). Beyond the banking sector, the cross-sectoral interaction among standard-setting bodies, regulators and supervisors has been extensive and unprecedented.
Basel Committee Membership and the Basel Consultative Group
Pre-crisis, the Basel Committee had 13 member jurisdictions. Today, the membership spans 28 jurisdictions and includes 45 central banks and supervisory authorities along with nine observers who participate in Basel Committee meetings and those of its various working groups.
Expansion of the Committee’s membership was one of several measures taken to improve global interaction among authorities. In 2009, the Committee established its Basel Consultative Group (BCG), which provides a forum for deepening the Committee’s engagement with supervisors around the world. The BCG facilitates dialogue with nonmember supervisors on new Committee initiatives. Its membership is made up of central banks and supervisory authorities from an additional 14 countries, as well as supervisory groups, international agencies, and other bodies.
International Conference of Banking Supervisors
Another important plank in the Committee’s efforts to forge international supervisory cooperation is the ICBS, which has been held every two years since 1979. The conference brings together senior bank supervisors and central bankers from more than 100 countries as well as representatives of international agencies. The conference promotes discussion of key supervisory issues and fosters continuing cooperation in the oversight of internationally active banks. With its wide membership of senior supervisors and policymakers, the ICBS fosters broad-based discussions on issues that are timely and relevant to supervisors in advanced and emerging market economy jurisdictions alike.
The Committee first published its “Principles for Effective Supervisory Colleges” in 2010 and a revised version in 2014. Authorities have established supervisory colleges to more effectively supervise global systemically important banks and other internationally active banking groups. This has been achieved by improved information-sharing among supervisors, building a common understanding of risks and vulnerabilities in banking groups, promoting a shared agenda for addressing such risks and vulnerabilities, and communicating key supervisory messages among college members. Supervisory colleges help their members form a deeper understanding of a bank’s risk profile and provide a framework for addressing topics relevant to the supervision of a banking group. Home and host supervisors are responsible for making risk assessments in their respective jurisdictions while information exchange organized at the supervisory college level plays an important role in contributing to these assessments.
The financial system is complex, global, and highly interconnected. This is true of all its sectors, such as banking, insurance, securities markets, and key market infrastructures, such as payment and settlement systems. The level of coordination among those responsible for each of these sectors has increased dramatically compared with the pre-crisis period. For example, as the standard setter for the banking sector, the Basel Committee keeps in regular contact with the International Association of Insurance Supervisors, the International Organization of Securities Commissions (IOSCO), and the Committee on Payments and Market Infrastructures (CPMI). These organizations often collaborate to set standards for overlapping financial sectors. For example, in 2013, the Basel Committee and IOSCO worked closely together in developing the global standard on margin requirements for non-centrally cleared derivatives. Also, in 2014, the Committee completed its work on the regulatory capital treatment of bank exposures to central counterparties, following a collaborative effort between the Committee, CPMI, and IOSCO.
I believe this cross-border and cross-sectoral engagement has taught some important lessons to all involved. It has underscored the need to respect other jurisdictions’ supervisory and regulatory decisions in the light of national circumstances (while still meeting the minimum global standards). It has also highlighted the need to understand and respect each standards-setting body’s mandates and objectives.
As the global regulatory framework has been radically transformed over the past decade and jurisdictions continue the process of implementing the national regulations, the Committee has shifted its focus from policy development to assessing, evaluating, and monitoring the new or revised standards. Much of the regulatory framework is new, such as the leverage ratio, the liquidity coverage ratio, the net stable funding ratio, and the use of regulatory capital buffers. The standards were agreed upon based on thorough quantitative impact testing and careful public consultation. However, because implementation has started only recently, we now need to assess the real-world impact of the standards.
Assessment, evaluation, monitoring – these activities now constitute a large part of the Committee’s work program. This is a challenging but necessary task. Necessary, given the importance of global minimum standards and the need to help ensure the resilience of banks and banking systems, but challenging because, in many ways, we are trying to hit a moving target. Studies to gauge the quantitative impact of the reforms have limitations – that is, they assume bank balance sheets will remain static when in fact banks will optimize the rules even before they officially come into effect. Also, and as I have noted elsewhere, the quality of data submitted by banks for such studies is never perfect. Nevertheless, on the basis of evidence and analysis, the Committee will assess whether its new or revised standards are meeting their original objectives, what the impact might be, and whether the impact is as expected or if there are unintended consequences. Only on the basis of empirical, data-driven analysis will the Committee consider whether adjustments are warranted.
As I have outlined above, the official sector has responded energetically to the imperative for effective and timely communication, coordination, cooperation, and consultation. The Committee’s response has substantially improved the global minimum standards, which form the basis for national laws, directives, rules, and regulations that implement the standards in Committee member jurisdictions. The implementation of additional measures, such as ring-fencing schemes, stress-testing frameworks, deposit insurance guarantees, and resolution regimes – which go beyond the minimum standards – are actions taken by national or jurisdictional authorities that reflect and respect national circumstances.
The Committee has become a truly global organization and has played a key role in promoting and facilitating the four “C’s”: communication, coordination, cooperation, and consultation. In addition, the level of engagement among those responsible for global standard setting, regulation, supervision, and oversight has improved dramatically. In addition, after a decade of developing new policies and revising existing ones, the Basel III framework published in 2017 provides certainty and stability. The Committee will nevertheless carefully assess, evaluate, and monitor the new standards to ensure they are producing the anticipated impact. n
As Secretary General, William Coen directs the work of the Basel Committee on Banking Supervision and manages its Secretariat. Coen chairs the Committee’s Policy Development Group and the Committee’s Coherence and Calibration Task Force. He also chaired the Committee’s Corporate Governance Task Force and is a member of the IFRS Advisory Council.
Prior to his appointment as Secretary General in 2014, Coen served from 2007 as Deputy Secretary General. His responsibilities focused on the Committee’s response to the global financial crisis, including the coordination of the Committee’s various Basel III initiatives.
Coen joined the Committee’s Secretariat in 1999 and had previously worked for the Board of Governors of the Federal Reserve System in Washington, D.C., as well as for the U.S. Office of the Comptroller of the Currency. He began his career as a credit officer at a New York City-based bank. He is a native of New York City and received his MBA degree from Fordham University and a B.S. from Manhattan College.