The meaning of Basel: Cohen, Spillenkothen, Stiglitz speak out

By Christine Harper
(c) 2010 Bloomberg News
Sunday, September 12, 2010; 10:48 PM

The Basel financial regulators' decision to more than double bank capital requirements worldwide -- while allowing eight years to comply -- triggered conflicting responses among experts ranging from Nobel laureate Joseph E. Stiglitz to Wall Street lawyer H. Rodgin Cohen.

Stiglitz, 67, said the "unconscionable" delay will expose the public to risk, while Cohen, 66, predicted the market may "penalize immediately" lenders that currently fall short. Paul Miller, 49, a former bank examiner who is now an analyst at FBR Capital Markets Corp., called the new rules "easy" and predicted they won't prompt capital-raising by any big U.S. firms.

Following are comments from Stiglitz, a professor at Columbia University in New York; Cohen, the senior chairman of Sullivan & Cromwell LLP, also in New York; Miller, in Arlington, Virginia; Simon Johnson, 47, a former International Monetary Fund chief economist and now a professor at the Massachusetts Institute of Technology's Sloan School of Management, in Cambridge; and Richard Spillenkothen, a former head of banking and supervision at the Federal Reserve Board and ex-member of the Basel panel, now a director at Deloitte & Touche in New York. All spoke in phone interviews yesterday.

They reacted to an announcement yesterday from the Basel Committee on Banking Supervision, which said it will require lenders to maintain common equity equal to at least 7 percent of their assets, weighted according to risk, including a 2.5 percent buffer to withstand future stress. Banks have less than five years to comply with the minimum ratios and until Jan. 1, 2019, to meet the buffer requirements. Definitions of what counts as capital and how risk is assessed were tightened.

H. Rodgin Cohen

"The real question is whether the BIS will be right and that the market won't penalize immediately the institutions that fall short of the requirements," he said, referring to the Bank for International Settlements.

An example is the treatment of mortgage-servicing rights. "If they will be difficult to hold because of an extraordinary capital charge in the future, does that mean banks will be less willing to originate and hold and sell mortgage-servicing rights? It's just astonishing to me that you would give zero value to a fundamental element of the mortgage business."

"Worse than any rule is uncertainty. The fact that the surcharge for systemically important institutions remains undealt with continues to create that uncertainty."

During the past 10 years, the largest U.S. banks have maintained an average voluntary capital cushion of about 170 basis points, or 1.7 percentage points, over the minimum requirement, he said. The question is whether firms will maintain that amount over the capital conservation buffer.

"There's even more of a need to maintain this voluntary cushion than there was in the past" because of mark-to-market accounting requirements. A 1 percent buffer applied to the U.S. banking system equates to $140 billion in capital, he said.

"One can argue that this is very negative in relative terms for the U.S. banks because many of the deductions are uniquely a U.S. problem and make a huge difference," he said, citing mortgage-servicing rights and deferred tax assets in particular.

Under new definitions, he estimates Tier 1 common equity ratios for U.S. banks drop to 4 percent from 6.5 percent, mainly because of changes in the definition of capital. There will be some changes in asset risk weighting as well, he said.

New liquidity requirements may increase holdings of sovereign debt, he said.

"If it's almost a requirement to hold sovereign debt, what does that do to the functioning of the overall debt market?"

Simon Johnson

"They couldn't do nothing after the greatest financial crisis since World War II, so they ended up doing the minimum. Even people I know who are pessimistic about the process are going to be disappointed."

"You should have gotten to 15 percent one way or another," he said of capital requirements. "When times are good you should have capital requirements up to 20 percent."

"This is not contractionary if you raise capital in the right way. If you tell people to target the ratio, then yes they may shrink the asset side of their balance sheet but if you make them raise capital, which is what they did in the U.S. after the stress test, then that is not at all contractionary."

Paul Miller

"A year ago, I wrote that it's not financial reform that's a big deal, it's Basel. But to me, Basel blinked. Today, most of these banks can already live up to these capital rules, especially because what they're using is risk-weighted assets."

"There are two different ways to look at this: There's risk-weighted assets and there's tangible assets. They are going to be using in the denominator risk-weighted assets, which can be gamed, it will be gamed, it always has been gamed. But by using that it lowers the bar. So it looks like they're being really tough on the top number, but by using risk-weighted assets most banks fall into the category already and are fine."

"It really does hurt the European banks. I would have liked to see them come out tougher, I thought they were going to come out tougher, but in reality they couldn't because of the position of the European banks."

"And they're also giving eight years to meet all these criteria, when all is said and done, and that's a very long time."

"Most of the banks in the U.S. already meet the criteria. It's very easy, nobody's going to be raising capital because of this -- maybe some small institutions but none of the big boys."

"What Basel is doing is different from what the U.S. regulators are doing. U.S. regulators have a high bar. They're going to use tangible common equity to tangible assets we believe north of 7 percent before they start allowing banks to pay dividends."

"This is all in the news from last week. The stocks didn't really react. I think you can get more clarity, and I think you'll see the stocks moving up."

Richard Spillenkothen

"These are significant increases, but there's also a reflection that the central bank governors and policy makers and regulators who worked on this understand that in some cases it will take some organizations some time to get there."

"It reflects a kind of pragmatism, significantly increasing the standards but also doing it in a way that attempts to avoid a serious adverse impact on the economy."

"You will see some market pressure to meet the standards before the transition period expires. Even in 1988, when we did the first Basel accord, there was a transition period there as well, but also a lot of organizations wanted to get to the final standard before the four- or five-year period of transition ran out."

"I consider these substantial increases in the minimums, but I think there's still a lot of other issues that need to be addressed -- liquidity, risk management practices, governance -- a lot of things that still have to be part of the overall regulatory reform effort."

Joseph E. Stiglitz

"It's a move in the right direction. One should see these actions as part of trying to correct what is clearly a dysfunctional banking sector."

"While it's understandable, given the weaknesses and the failings of the banking system, that one would want to be slow in introducing these increased capital requirements, delay is exposing the public to continued risk. Given the high levels of payouts in bonuses and dividends, it seems a little unconscionable to continue putting the public at risk with an argument that they cannot more rapidly increase their own capital."

"The banks have complained about the fact that increased capital adequacy requirements of this kind would increase the cost of capital that firms would have to pay. But one should recognize that through the bailouts that have been repeated all through the world, not just during this crisis, the public has in effect been subsidizing the banking sector and that represents a very large distortion in the financial system. If the cost of capital is higher as a result, it's just undoing a distortionary subsidy."

"Any assessment of the full impact depends obviously in part on the accounting standards. If banks are allowed to continue the kind of deceptive accounting where they can treat non-performing or impaired mortgages as if they were fully performing, it undermines the effectiveness of these attempts to ensure that banks are adequately capitalized."

The collapse of Lehman Brothers Holdings Inc. in 2008 "provides an example par excellence" because of the gap between its stated capital and actual capital when it went bankrupt.

© 2010