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Reason Foundation

New Basel Rules Could Punish Wrong Banks

Anthony Randazzo
November 2, 2010, 8:45am

The new Basel rules for bank capital requirements are aimed at making the financial sector safe. But quadrupling the percentage of capital banks have to hold on to in a system that is basically the same as the one governing global finance during the bubble and great recession isn't the way to prevent future excessive risk taking. Instead, rules should find ways to force banks to take responsibility for their own risks. Why? Because the current framework for capital requirements runs serious risks of negative unintended consequences. Jacques de Larosière explains in the Financial Times:

But such “re-regulation” can have unintended consequences. It could encourage a transfer of heavily taxed operations in terms of capital requirements, such as trading, to the so-called shadow banking system, outside the scope of regulation and supervision. Such shifts may endanger financial stability unless current re-regulation is accompanied by new regulatory and supervisory structures for “non-banks”. Efforts in this respect are under way but they are still at the project stage, and will take time.

If banks had to take responsibility for their own risks it wouldn't matter where the risks are at. But if they just have a number to worry about and bailout behind them, then its just a matter of fancy accounting. Next:

The second big cause for concern touches specifically on European banks and their business model. The new Basel capital and liquidity rules would, in the medium term, lead to reduced profits and increased competition regarding the generation of deposits. This inevitable rise in costs would have to be offset by higher productivity and, no doubt, higher costs for banks’ clients. Under pressure from extended competition, certain banks will be encouraged to operate in a way that is more profitable but at the same time more risky.

See the rest of the FT piece here.


Anthony Randazzo is Director of Economic Research


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