Tough new global financial rules are a must

Monday, August 9, 2010

THE JOB OF re-regulating the financial system is only partly done. The United States has passed a bill, but new international rules remain to be written. As we have noted, nothing is more important to assuring financial stability than strong standards for bank capital -- the reserves institutions must set aside to maintain solvency in times of economic stress. The task of setting capital standards for global banks, and ensuring that they apply roughly equally around the world, falls to the representatives of leading nations who make up the Basel Committee on Banking Supervision, based in Switzerland. With its rules, known as Basel II, having been exposed as too lax, the Basel group has promised to produce tougher ones by November, when leaders of the world's 20 top economies meet in Seoul. The problem is that banks are trying to water down the forthcoming Basel III accords.

In its latest draft, the Basel group relaxed what was supposed to have been a fairly firm requirement that banks maintain $3 in core capital -- in the form of common stock and retained earnings -- for every $100 in assets. This "leverage cap" will now be delayed until 2015 and phased in thereafter. Also softened: the proposal for stable long-term funding, which won't take effect fully until January 2018.

Most of the pressure for these tweaks came from Europe's banks and governments, which claimed that excessive pressure to raise capital would force banks to curtail their lending and, by extension, harm economic growth. To be sure, there is an inherent trade-off between banks' freedom to fund expansion on the one hand and their safety on the other. Overregulation could indeed choke off prosperity. But much of Europe's hesitation represents the special pleading of a region whose financial sector has not fully come to grips with dubious practices that helped bring the eurozone to the brink of disaster.

Germany has not yet signed off on even the modified Basel draft, despite reports that the leverage cap was altered to meet the concerns of giant Deutsche Bank -- which is more highly leveraged than its U.S. counterparts. Berlin wants the regulators to let its large, interlocking network of state-backed local and regional banks continue counting government support as a form of capital.

For some banks and the governments that subsidize them, it will never be the right time to accept strict, prudential regulation. For the public, however, the calculus is different. Any possible negative effect on growth in the short run must be weighed against the longer-term risk of another financial and economic meltdown. The clear lesson of the recent crisis is better safe than sorry, and the Basel group should act on it.

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