Basel III Is Here

Basel III is here. Felix Salmon has a great write-up of the following chart:

Richard Smith at Naked Capitalism has more.

First off, congratulations to Treasury on pulling this off as well as they did. Capital reserving isn’t going to be everything, but it is going to be a very important part of financial reform, and as someone who was very pessimistic on Basel III this is pretty much what I would have asked for.

If you want to see the importance of the countercyclical buffer, which requires banks to hold more capital in good times and as the economy is expanding, check out this chart from the Boston Fed:

As the housing bubble was getting into its worst phase in 2005 you can see many of the major investment banks take on higher leverage and hold less capital. Under Basel they’ll have to lean against that, which is a very wise move for stability and soundness concerns.

The battles that are fought alongside this are off-balance sheet reform and other ways of defining capital, and Basel III looks to be doing well here as well:

The Committee agreed on the following design and calibration for the leverage ratio, which would serve as the basis for testing during the parallel run period:

– For off-balance-sheet (OBS) items, use uniform credit conversion factors (CCFs), with a 10% CCF for unconditionally cancellable OBS commitments (subject to further review to ensure that the 10% CCF is appropriately conservative based on historical experience).

– For all derivatives (including credit derivatives), apply Basel II netting plus a simple measure of potential future exposure based on the standardised factors of the current exposure method. This ensures that all derivatives are converted in a consistent manner to a “loan equivalent” amount.

– The leverage ratio will be calculated as an average over the quarter.

There is also the battle for liquidity reserving, which Economics of Contempt wrote about here. I also noticed, in defining counterparty risk managament, that “Banks’ mark-to-market and collateral exposures to a central counterparty (CCP) should be subject to a modest risk weight, for example in the 1-3% range, so that banks remain cognisant that CCP exposures are not risk free”, which is very encouraging, as regulating clearinghouses will be a major part of the implementation of this bill, and requiring banks to not treat them as risk-free is very important. The issue of ratings for debt is still in play, so ratings agency reform is need to move as well.

I still would have liked to see a few hard rules hardwired into the Dodd-Frank bill as a last line of defense; implementation of Basel III is not a done deal, and clever future administrations can monkey around with it in all kinds of ways. But for now, a win.