US battles Basel III rules

AFTER several regional US banks collapsed in 2023 and with the volatility in the private credit market, where US banks have reportedly loaned about US$300bil, one expects US financial services regulators to tighten the rules.

Instead, these regulators are loosening controls that were agreed to under the Basel III international capital and liquidity standards in the wake of the 2008/2009 global financial crisis.

With lower capital requirements, banks can then free up cash to deploy and leverage.

These rules were rolled out to curb reckless risk-taking in the banking industry across the world and in particular, Wall Street, which is home to a significant number of important banks in the global system.

The final set of rules, known as the Basel III Endgame, which calls for higher capital buffers to be implemented from 2023 to 2028, saw intense pushback from US banks.

They feel these rules constrained their capacity to lend as well as curb their ability to assess risks independently for risk-weighted assets.

The US Federal Reserve and other regulators overseeing financial services in March proposed to lower the capital requirements for these large US banks, and even the regional banks and smaller banks.

That would see their capital requirements lowered significantly, and these regional banks, despite having seen several collapses and bank runs in 2023, will still see less onerous requirements under the Basel III Endgame scope.

US banks are not the only ones who have lobbied against the more stringent rules under the Basel III Endgame.

European banks have also been lobbying against it, as they fear US banks having a competitive edge. Western Europe is also home to a number of globally important banks.

Seeing the coming onslaught of these US rule changes, the Bank of England last December lowered capital requirements that remained Basel III compliant but gives UK banks a better edge.

One of the arguments among the globally important US banks is that they have high capital buffers, so do not need to be constricted by more rules.

According to the International Monetary Fund, these banks and their competitors in Europe and Japan have common equity tier-1 (CET-1) ratios of between 12% and 16%.

CET-1 is the gold-standard in capital buffer that enable banks to continue operations even during economic downturns and are required to be stress-tested regularly.

The CET-1 ratios for large US banks as set by the Fed is layered with a minimum CET-1 capital ratio requirement of 4.5%, including for the big banks.

The stress capital buffer requirement, which is determined from the supervisory stress test results is at least 2.5%.

For globally important banks, a capital surcharge, where applicable, of at least 1% to up to 3.5% is added.

The proposed revised Basel III Endgame scope for US banks comes at a time of heightened economic competition, from the US-China trade war to the truncated US tariffs imposed across the world, which is still winding its way through the US courts on its legality.

Global banks, by their nature, are at the forefront of this competition as they offer capital for funding, which includes pouring in billions into technology such as software, chips development and data centres.

The Basel III guardrails on liquidity, leverage and capital requirements were set up for a reason and lowering standards can cause global systemic problems.

In the event of another global financial crisis type event, and without the enhanced rules of the Basel III Endgame, will US or European banking regulators step in to assist or rescue, or will the increasing fissures from economic competition make them choose national interest first?