It is almost unavoidable that any international agreement ends up as a camel – that well-known analogy for a horse designed by committee. The final text of Basel III was a smorgasbord of priorities, reprieves and vetoes rather than a singular vision of what post-crisis financial regulation should look like.
While key Asian jurisdictions, the US and the large European countries in the driving seat of the European Union constructed a package that carefully avoided any major capital increases in their home markets, the Nordic region has taken the brunt of the new rules. One lobbyist’s estimate is a 30% capital increase at Nordic banks, compared with what the Basel Committee has said will be a zero aggregate increase globally. The question is whether this is justified.
On December 7, Basel Committee chairman Stefan Ingves said the new rules had been designed “to catch the outliers”. It is true that risk weights for corporate loans and mortgage books at banks in the Nordic region have been, in many cases, significantly lower than elsewhere since 2008. But local banks argue that this has been based on historic losses and sophisticated modelling, rather than an attempt at regulatory arbitrage.
The need to catch outliers and limit aggressive modelling by applying the agreed output floor set at 72.5% of Basel standardised approaches is arguably strongest if there is an unlevel playing field. In other words, if one bank is holding much less capital than another by using an internal model yet undertaking the same business. But Julie Galbo, chief risk officer at Nordea, points out that mortgage markets are in fact nationally specific, with different loss histories and very different insolvency procedures. Most are dominated by domestic banks. Reflecting these differences in the risk weights applied by those banks is, therefore, common sense.
When one of the most financially stable regional markets in the world ends up a victim of the new rules, something has gone wrong
Regulators’ attempts to reduce the reliance on internal model outputs and external credit ratings is commendable given the experience of the financial crisis, but when one of the most financially stable regional markets in the world ends up a victim of the new rules, something has gone wrong. This is especially unfair when sovereign risk – responsible for devastating the Greek and Cypriot banking sectors in recent years and largely concentrated at southern and peripheral European banks – has not been addressed at all by Basel III. Meanwhile, the market risk rules, which could have a significant impact on the giant US dealers, have been delayed.
One of the answers, if the floor is to be maintained at 72.5% in Europe, is greater risk granularity in the standardised formula. Basel has tried to introduce this, but the changes to standardised risk weights for mortgages focus on variance in loan-to-value ratios. That is likely to mean an even greater impact in the Nordic and Dutch regions where LTV ratios are historically high owing to the low loss experience. A greater sensitivity to national markets, loss histories and other datasets would complement the right balance between financing on the one hand and risk management on the other. This is currently missing from the Basel rules.
National interests were key to the negotiating position of different Basel committee members, but a smaller region with less influence on the world stage should not have to embrace rules that don’t make sense for its banks and real economy.
Nordic lobbyists now have a bigger chance to influence EU policymakers for the actual implementation of Basel III, and Finland might be able to influence the drafting of legislation when it holds the rotating presidency of the EU Council in the latter half of 2019. But a region with 72 out of 751 members in the European Parliament could still, once again, end up a rule-taker rather than a rule-maker.