Are international capital requirements proposed by the BIS enough?

September 20th, 2010

BIS Headquarters in Basel | Photo: W.RonaldLee9, Picasa

Central Bank Governors met in Basel, Switzerland earlier this month and proposed tripling the capital reserve requirement to 7 percent. This came shortly after the Financial Stability Board and Basel Committee for Banking Supervision released a joint statement that said that the benefits of implementing stronger capital and liquidity requirements – which increase the safety and soundness of the banking system – would have net, long-term benefits for the global economy.  Many banks argue that having to comply with higher capital requirements by holding onto more of their money would hamper economic development and slow the banks’ lending.

The August joint statement by the FSB and Basel Committee said that if the capital and liquidity requirements are phased in over four years,  for every 1% increase in the ratio of capital to risk-weighted assets that banks are asked to keep, growth would fall by only 0.04% a year over four years. They said a 25% increase in liquid assets held by banks would have less than half of the effect of a 1% rise in capital ratios over the same period. In short, increasing the requirements and enhancing safety and soundness of the global banking system has nominal effect on economic growth.

This is all good news for working towards a more stable international banking and investment structure, however in order to have a powerful impact on structurally transforming the global financial system, these stronger regulations must be paired with measures for increased financial transparency. Requiring banks to hold more money to protect themselves, and the system as a whole, from breakdown does not address the very serious problem of all of the illegal activities and illegal money transfers that undermine all efforts at sustained economic stability and development. Financial transparency is key in working toward the curtailment of these detrimental illicit flows.

Curbing illicit flows matters because illicit flows mainly 1) hamper both economic development and the reduction in income inequality, 2) facilitate corrupt political behavior and infractions on human rights, and 3) undermine global economic and financial stability. Each of these issues merits discussion in great length. I’m reintroducing the larger picture to place a call for transparency into context.

Mr Nout Wellink, Chairman of the Basel Committee and President of the Netherlands Bank, said “The economic benefits of the proposed reforms are substantial and need to be considered alongside the analysis of the costs. These benefits result not only from a stronger banking system in the long run, but also from greater confidence in the stability of the financial system as soon as implementation starts.” To bring significant stability to the global banking system and the global economy as a whole, we must work towards multilateral policies for transparency and information sharing. Structural and regulatory adjustments to the US and International banking system are a move in the right direction, but must be complimented with laws and common practices of more financial transparency from reporting to cross-agency and cross-border information sharing.

The joint FSB-BCBS Macroeconomic Assessment Group (MAG) is preparing a final report on global capital and liquidity standards to be delivered in advance of the Seoul G20 Leaders summit. Hopefully, at some point, the necessity of increased transparency measures will be clear to policy makers who can no longer ignore the horrifying ramifications of not working quickly toward more responsible and comprehensive banking and investment requirements including increased reporting and information sharing measures.

Written by Karly Curcio

Follow @FinTrCo