Financial reform's unfinished agenda

Tuesday, July 6, 2010

AKEY CAUSE of the financial crisis was that financial institutions took on far too much leverage -- they risked vast multiples of capital, rendering them vulnerable to the slightest downturn in asset prices. It follows that regulators should set higher capital requirements. "The top three things to get done," Treasury Secretary Timothy F. Geithner told the New York Times in March, "are capital, capital and capital." The Dodd-Frank financial reform bill authorizes and encourages higher capital requirements but leaves the details up to regulators.

U.S. regulators, in turn, must await the outcome of an obscure discussion among technocrats meeting under the auspices of the Basel Committee on Banking Supervision. Named for its Swiss headquarters, this international group sets capital standards for banks around the world, on the sound theory that countries should present multinational banks with a united regulatory front. The Basel group has been blamed for contributing to the recent crisis because it had contemplated capital standards based on banks' unrealistically low calculations of risk in their portfolios. The current negotiations are supposed to rectify that. Leaders of the Group of 20 nations have promised that "the amount of capital will be significantly higher and the quality of capital will be significantly improved."

The Basel group has until November, when the G-20 meets again, to fulfill that pledge. Yet banks are resisting what amounts to a tax on their profits and a constraint on their business model. They have a point. Capital is not as simple to define as it appears. Hoarding too much reduces lending, thus contributing to the very global economic slump regulators are trying to avoid. Canada's cautious banks survived the crisis well and see no need to raise capital. In Europe, banks need capital but would rather not be forced to admit that. Acknowledging this discord, G-20 leaders said that "phase-in arrangements will reflect different national starting points and circumstances." Too much deference to national differences, though, would defeat the whole purpose of the exercise.

Obviously, balances must be struck. Tougher limits on leverage create some downside risk to growth, but that would be offset by the bullish impact of regulatory uniformity and stability. A phase-in period for the new standards is appropriate -- as long as it's the same for everybody. Mr. Geithner, who urged Congress not to preempt the Basel process as it considered the Dodd-Frank bill, must now remember his wise words of March and act on them.

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