Basel III and global cooperation: where do we go from here?
Keynote speech by Carolyn Rogers, Secretary General of the Basel Committee on Banking Supervision, at the The Kangaroo Group virtual debate, 8 September 2021.
Introduction
Good afternoon, and thank you for inviting me to speak at this virtual debate of the Kangaroo Group's Working Group on Financial Services on the finalisation of the Basel III framework.
When I received your invitation, the name of your group caught my attention: I must admit to needing to do a bit of research to find out what possible interest a group interested in kangaroos would have in bank regulation. But I was pleased to discover that your organisation has a lot in common with the Basel Committee. Both of our organisations are founded on the value of cooperation in achieving better policy outcomes, and your goal of ensuring the full implementation of various EU-specific initiatives aligns closely with the Committee's expectation of full, timely and consistent implementation of its global standards.
So I am of course very happy to be here today and to have the opportunity to speak with a like-minded group.
The timing of today's debate is also opportune. As we all know, the European Commission is due to release its proposal on transposing the final Basel III reforms into EU law. That makes this a pivotal time – both for preserving and strengthening financial stability and for the role of multilateralism.
I intend to use my remarks today to remind us of the important connection between these two topics – multilateralism and financial stability. I will also take the opportunity to respond as directly as possible to some of the arguments circulating against the full implementation of Basel III in the EU.
Global cooperation and financial stability
The past decade has been a difficult one for multilateralism. Geopolitical, economic and societal shifts have, at times, created scepticism or even mistrust in cross-border cooperation. The role of some international organisations was called into question and the commitment to existing agreements was tested. The Covid-19 pandemic was, at once, a further strain on global cooperation, and a stark reminder of its necessity.
The world is a more interconnected and interdependent place now. Protecting the health and financial stability of our countries necessarily requires us to think of these values as global public goods, and therefore to think past our own borders.
This principle – that financial stability is a global public good – is what underpins the standards set by the Basel Committee. An open, global financial system – a choice the world has already made – requires global standards for safety and soundness. Without them, the potential underinvestment of any one jurisdiction in financial stability can result in spill over effects for other jurisdictions. Global regulatory cooperation is therefore an imperative as long as we value a global financial system and global financial stability.
Fortunately, despite a challenging time for global cooperation, the past decade has been one of the most productive for the Basel Committee. The Great Financial Crisis (GFC) of 2007– 09 and its aftermath led to a global resolve for change. Central banks and supervisory authorities came together quickly and agreed on a comprehensive strategy to address the shortcomings in the banking system.1 In September 2010 the Group of Governors and Heads of Supervision – the Basel Committee's governing body – announced higher global minimum capital standards for internationally active banks2 and later that year, the Committee agreed to the design of the capital and liquidity reform package, now referred to as "Basel III".3
From 2011 to 2016, despite a slight waning of the global resolve for change as memories of the financial crises started to fade, the Committee's member jurisdictions continued to cooperate closely. With improved minimum standards now in place, the focus shifted to ensuring the measurement of those standards was also robust and consistent across all global banks.
The Committee completed the last plank of the Basel III reforms in 2017, with the publication of new standards for credit risk, credit valuation adjustment risk and operational risk.4 The final reforms also incorporate a leverage ratio and an output floor, two complementary measures that improve the consistency and comparability of the overall regime by reducing opportunities for arbitrage.
More recently, the Committee demonstrated its capacity for agility, flexibility and cooperation when it acted quickly and decisively at the onset of the pandemic and agreed on a set of policy measures to help banks remain resilient and continue to lend to households and businesses through a period of unprecedented economic uncertainty.5
Time and again, the Committee has shown its ability to work collectively in a timely manner to strengthen the resilience of the global banking system. And while it is relatively easy to summarise this great track record in a speech, I assure you the work is much harder. The decisions reached by the Committee come after thorough research and analysis, extensive consultation and hours upon hours of discussion and debate.
Before I was the Secretary General for the Committee, I was a member of the Committee, representing the financial regulator in Canada. It was my job to ensure the Committee's deliberations were informed by an understanding of the Canadian banking system, including those things that I saw as unique about our banks or our economy. Like all my fellow Committee members, I took this job seriously.
And because all Committee members take this job seriously, a consensus is not always quick or easy to reach. As I have learned over the last two years, this makes the job of the Secretary General a challenging one. But this is ultimately the strength of the Basel Committee: the ability of a group to overcome individual differences in the interest of solutions that benefit the global public good.
Given the audience of this debate, I should note the important role that Europe plays in the Committee's ongoing cooperation. Approximately one third of the Committee's membership hails from Europe. The European Central Bank, the Single Supervisory Mechanism, the European Banking Authority and the European Commission are all important and active contributors to the work of the Committee. Since its inception, the Committee has had 11 Chairs, with nine of them hailing from Europe. In my own personal experience with the Committee, I have come to appreciate our European members as some of the toughest negotiators, but also the fiercest advocates for multilateralism. Our European members worked very hard to achieve a global consensus on Basel III.
It is also worth noting the tremendous progress made within Europe in the past decade when it comes to collaborating on financial stability issues. The introduction of the Single Supervisory Mechanism, the Single Resolution Board and Single Rulebook – all important components of the Banking Union – are significant accomplishments. They also share common objectives with the Basel standards: more transparent, unified and safer oversight of banks, preventing problems in one market from spilling over and creating distress in other markets, and ensuring that banks can weather tough times without taxpayer support. And, as is the case with Basel III, there are important, outstanding elements of the Banking Union that need to be implemented for the full benefits to be realised. Nevertheless, it is important to acknowledge the progress to date.
Global cooperation and Basel III
As challenging as reaching a final consensus on Basel III at the Committee table was, it was not the last step. The last step requires translation of the Committee's hard work into its ultimate objective of enhancing global financial stability, and that step is only achieved when each of our member jurisdictions implements the agreed standards domestically. The path to implementation varies across jurisdictions, and as with many things in life, the last mile is often the hardest. But it is also the most important and most consequential - both to achieving global financial stability and to preserving multilateralism.
I have previously referred to the implementation of global standards as being a lot like a two-legged football game.6 After the first "away" game in Basel, a second "home" game takes place, where banks and trade associations lobby vigorously to reopen elements of the global framework. Regrettably, this second leg, aided by "home field advantage" has resulted in cases where the standards implemented at the national level are not fully compliant with the Basel framework, including here in Europe.7
So, where are we at when it comes to the implementing the outstanding Basel III standards? On the one hand, I take great comfort when I hear my European Basel Committee colleagues consistently reiterate their commitment to implementing these standards in a full, timely and consistent manner, in line with the repeated pledge by G20 Leaders. I am also reassured by the repeated calls by key EU policymakers for Europe to demonstrate its commitment to multilateralism and international cooperation by implementing Basel III as it was agreed.
On the other hand, I am concerned that some stakeholders continue to lobby against a consistent and timely implementation of Basel III. Their arguments aren't new, but in some cases have been they have been repurposed for the latest context or set of circumstances. I will use the balance of my remarks today to address, as directly as possible, the most common arguments.
First is the assertion that the broadly positive state of the banking system thus far during the pandemic proves that no additional measures are needed to strengthen its resilience. True, the global banking system has remained resilient to date. Bank lending to households and businesses grew last year by 9% in advanced economies and 15% in emerging market economies. We have not seen a repeat of banks' crisis-exacerbating behaviour to date, unlike during the GFC.
But let us be very clear about what has been behind this stability thus far: the banking system has benefited tremendously from the unprecedented scale and scope of public support measures, spanning fiscal, monetary and regulatory actions. Whether it is government guarantees for bank lending, job furlough schemes, wide-ranging liquidity support or various forms of regulatory and supervisory forbearance, these support measures have done much of the heavy lifting thus far and shielded banks from shocks and losses.
What is more, the pandemic is not a typical financial crisis fuelled by a credit boom, excessive leverage and lapses in risk management. So, in many ways, the last 20 months have not fully tested the resilience of the banking system, and it has certainly not tested the banking system's resilience in the absence of large-scale public support.
Indeed, we know that there remain some fault lines – most notably with the way in which banks measure their capital requirements using internal models. These fault lines remain as important today as they were pre-pandemic, including in Europe, and they are exactly gaps that the final Basel III reforms target. Let me give just one example. The Committee's first report on the variability of banks' modelled capital numbers – which highlighted a worrying degree of variation and inconsistency – was in 2013.8 Eight years later, and despite repeated claims by some stakeholders that banks had "fixed" this problem, the latest report by the European Banking Authority on banks' modelled capital requirements points to a "significant" level of capital dispersion "that needs to be monitored".9 Implementing Basel III in full – and in particular the output floor - will go a long way toward addressing these persistent concerns. Far from being a reason to dilute or delay Basel III, the experience of global banks through the pandemic is another reminder of why we need global standards for resilience.
Second, some banks argue that certain parts of Basel III should not be implemented as agreed by the Basel Committee because they will be "disproportionately" impacted by them, relative to their peers. This argument is often supported by the suggestion that the final set of Basel III reforms included a commitment not to increase overall capital requirements.
In my view, a bank, or any stakeholder that argues that a global standard needs to be domestically adjusted to reduce the impact on outlier banks has lost sight of the purpose and value of global standards.
The primary objective of the outstanding Basel III reforms is to enhance the comparability of reported capital levels across all banks, by constraining the discretion they have to measure that capital using their own models. Put differently, these reforms level the global playing field and preserve trust and credibility in the capital levels published by banks. A level playing field reinforces trust and credibility and both are critical for financial stability, particularly in times of stress.
And we have always said that these measures will not significantly increase overall capital requirements at the global level. We have met this objective. Under very conservative assumptions, these measures are estimated to increase global banks' Tier 1 capital requirements by less than 2% if implemented immediately.10 This is equivalent to about 5% of annual dividend payments made by internationally active banks during the period 2015–2019, hardly a constraint, and a small price to pay for the benefits of added stability.11
Of course, there will be "outlier" banks that face higher requirements. Changes designed to increase the consistency of capital measurement – to level the playing field – will necessarily impact banks differentially. Banks that have benefited from aggressive modelling of their capital in the past, or that have been subject to rules that were not in line with prior Basel standards, will be impacted more. To be clear: this is an intended outcome.
But even in those instances where banks will see increased capital requirements, the actual impact is likely to be much lower than is asserted, not least because of the sufficiently long transitional arrangements. With a 2023 start date, the final elements of Basel III, including the output floor, will only be fully implemented by 2028 – a full 20 years after the GFC. Surely this is enough time.
Third, some have argued that now is not the time to implement Basel III because we are in a middle of a global pandemic and banks must support the economy. This is a version of the very tired argument that banks can either increase their resilience or support the economy – as though these two things were mutually exclusive objectives. Of course, they are not. In fact, they are mutually reinforcing objectives.
There is a long and growing list of rigorous, empirical studies that all come to the same conclusion: it is healthy, well-capitalised banks that lend to households and businesses, both in good times and bad.12 The last year only added to this experience. We saw jurisdictions with better capitalised banks experience a less severe impact on their expected GDP growth, and better capitalised banks increased their lending more during the pandemic, relative to their peers. The global economy faces a tough recovery ahead. All the more reason why we need strong, resilient and well-capitalised banks.
Fourth, some stakeholders have pointed to "national specificities", or unique features to a banking system or jurisdiction that demand a deviation from global standards. For example, I often hear about the dominant role of bank lending relative to other sources of financing in Europe, the distinct structure of housing markets in other markets or certain banks that are just too small to be held to a global standard.
These arguments belie the purpose of the Basel III standards. The Basel framework is designed and calibrated to create a global level playing field for internationally active banks. They are a common baseline that reflects, as much as possible, structural differences across jurisdictions.
The arguments also ignore the fact that the reforms are designed through an extensive and transparent process of consensus building that includes a wide range of empirical analysis and extensive public consultation.
In the case of Basel III, the Committee issued no fewer than 10 consultation papers as part of these reforms, with an accompanying consultation period that spanned the equivalent of almost three years. The finalised standards took on board many of the comments received from stakeholders and reflect the differences in views among our members. They are a compromise by their very nature.
Global cooperation and the future of the Basel Committee
In conclusion, multilateralism lies at the heart of the work of the Basel Committee. Looking ahead, there is no shortage of cross-border financial stability issues that will require global cooperation. Over the coming years, the Committee will tackle a range of challenges impacting the global banking system, including the impact of prolonged low interest rates, digitisation of finance, cyber threats and climate change, to name just a few. As we pursue our work, the Committee will maintain its transparent and consultative approach.
Most importantly, the Committee will rely on its members to continue to work collaboratively and constructively toward enhancing financial stability. Implementing Basel III in a full, timely and consistent manner is an important and powerful demonstration of this commitment to global cooperation.
References
Basel Committee on Banking Supervision (BCBS) (2008): "Comprehensive strategy to address the lessons of the banking crisis announced by the Basel Committee", press release, 20 November.
--- (2010): "Group of Governors and Heads of Supervision announces higher global minimum capital standards", press release,12 September.
--- (2013): Regulatory consistency assessment programme (RCAP) - analysis of risk-weighted assets for market risk, 31 January.
--- (2017): "Governors and Heads of Supervision finalise Basel III reforms", press release, 7 December.
--- (2020a): "Governors and Heads of Supervision announce deferral of Basel III implementation to increase operational capacity of banks and supervisors to respond to Covid-19", press release, 27 March.
--- (2020b): "Basel Committee meets; discusses impact of Covid-19; reiterates guidance on buffers", press release, 17 June.
--- (2020c): Eighteenth progress report on adoption of the Basel regulatory framework, July.
--- (2020d): Basel III monitoring report, December.
Borio, C, M Farag and N Tarashev (2020): "Post-crisis international financial regulatory reforms: a primer", BIS Working Papers, no 859, April.
European Banking Authority (2021): EBA report results from the 2020 market risk benchmarking exercise, EBA Papers, no 5, March.
Hernández de Cos, P (2021): "Crossing the Basel III implementation line", speech given at the Eurofi High-level Virtual Seminar, 15 April.
Rogers, C (2021a): "Levelling the playing field or: How I learned to stop worrying about market fragmentation and love global regulatory cooperation", speech at the ASIFMA virtual event, 25 February.
--- (2021b): "Three questions on the outlook for banking", speech at the IACPM virtual spring conference, 19 May.
Viterbo, A (2019): "The European Union in the transnational financial regulatory arena: the case of the Basel Committee on Banking Supervision", Journal of International Economic Law, vol 1, no 24, June
1 BCBS (2008).
2 BCBS (2010).
3 See Borio et al (2020) for a summary of the Basel III framework.
4 BCBS (2017).
5 BCBS (220a,b).
6 Rogers (2021a and 2021b).
7 See BCBS (2020c).
8 BCBS (2013).
9 EBA (2021).
10 BCBS (2020d).
11 Based on a sample of 105 large internationally active banks with Tier 1 capital greater than €3 billion.
12 Hernández de Cos (2021).