When the Dodd-Frank Act created Basel III, the underlying goal was the creation of a financial system in which banks are sufficiently cushioned by a capital framework that supports the firm’s survivability – or at least a move to a clean break – during times of financial stress.
But it seems the rules designed to save America from another financial crisis have created a few complexities of their own, Boston Federal Reserve Bank President Eric Rosengren said Monday. (Click here to access the full speech).
Rosengren is grateful that Basel III – under the umbrella of the Dodd-Frank Act – ushered in a new era with an added focus on ensuring banks possess enough capital to survive under various stress scenarios.
But the flipside to all the change is confusion, he says. And unfortunately, investors seeking clarity on various issues are finding it harder under the new regime to gain the clarity needed, Rosengren claims.
Pointing to a 2012 examination of annual reports from big banks, Rosengren found that banks spent pages of their reports discussing the lengthy regulatory requirements after the release of Basel III.
His takeaway from the reports: “This complexity makes evaluations of banks’ financial conditions challenging and makes it more difficult to make comparisons across banking organizations.”
Banks are struggling for several reasons, he says. The most major being the challenging transition from Basel I and II to Basel III. It takes years for firms to absorb new regulatory requirements, and in today’s market, they're still dealing with the old rules while making room for new ones.
As Rosengren points out many banks are still reporting under Basel I and II, while also working on Basel III requirements.
"This is primarily a transition problem, but the transition to full implementation of Basel III is not scheduled to be completed internationally for another five years," he noted. One way to simplify it would be to say that once big banks are compliant with Basel III, they should no longer report under older capital frameworks.
Another area of confusion is related to the rule’s use of both risk-based capital ratios and leverage ratios. With banks remaining so complex, both measures need to be used, the Boston Fed Bank president noted.
Rosengren says new liquidity requirements for banks will reduce “some of the mismatch," but may not be sufficient to resolve the entire problem.
Rosengren is not the first to challenge Basel III, or the transition to it. In recent years, the mortgage industry began questioning parts of the latest Basel regulatory regime, suggesting the rules may hinder mortgage lending and increase the cost of originating mortgages.
Rosengren’s Monday speech on financial supervision in Abu Dhabi shows Fed leaders realize Basel III brings a new set of challenges to the market.
His recommendation: focus on a narrower capital definition – such as Tier-1 common equity and move the emphasis to Basel III, removing overhang from the Basel I and II regulatory regimes.
