Yesterday, in far-off Basel, Switzerland, technocrats from countries around the world -- including the G-20 countries and the United States -- agreed to new international banking standards. This process needed to take place on the international stage -- and apply to countries across the board -- because unless standards are universal, we could see some pernicious business practices migrate to the least-regulated parts of the world. The essential take-away from this process is that governments agreed that banks will need to hold more than double their "common equity" -- straightforward ownership stakes, including capital that is less straightforward, like preferred stock, the requirement for more loosely defined "Tier 1" capital increases by a third, so that banks must hold total capital of 8 percent.
Also interesting: Banks must maintain a "capital conservation buffer" that prevents them from paying out dividends or taking other steps that would reduce their capitalization when their capital ratios are within 2.5 percent of the minimum requirement, so many banks will need to maintain a total capital ratio of 10.5 percent capital to liabilities; this is much higher than most banks carried during the crisis and higher than what many banks are carrying now.
Finally, there is also a countercyclical capital requirement that national regulators can apply of up to 2.5 percent of capital that would help deter the problems that come with the increased risk of a bubble as an economy heats up. That would mean that regulators would have to take note of the kind of conditions we saw in 2005-2007 and ask banks to hold more capital; while regulators' ability to spot a bubble is certainly widely debated (with answers ranging from they can't, they can but they won't, they could but they're too dumb/pernicious), at least this is a mandate for them to account for the kind of indicators at least some economists recognized in the run-up to the final crisis.
One thing that's important to note about these standards: They apply to all banks, but under the Dodd-Frank financial-reform bill, any systemically risky bank must be held to standards higher than these, which implies that the Goldmans and Citis of the world will be expected to maintain even higher ratios than these. The Basel III standards affirm that systemically risky institutions should be expected to carry more.
Questions remain over the implementation schedule for these new rules, which will be phased in over six years beginning in 2013, yet this decision represents a victory for the Obama administration, too, which has made higher capital requirements the centerpiece of its vision for regulatory reform, lessening the likelihood of a crisis and making banks less profitable. There will be disagreements over whether this is the right approach -- many progressives will argue that these standards are meaningless if banks are so large, or that regulators cannot enforce them -- but from the point of view of the White House and Treasury, this was what they were fighting for, and they'll own it, so executing these new standards will be a high priority for the next generation of regulators.
-- Tim Fernholz
