Beating Basel into American submission

Federal Reserve Gov. Daniel Tarullo talked to a room full of lawyers Friday about implementing international bank regulation in America. And if that alone didn’t confuse me enough, he dropped this Basel III bombshell: “I expect that we will, among other things, suggest recalibration of certain deposit run-off and commitment draw-down rates, as well as modification of the buffer definition to place a greater focus on the liquidity characteristics of assets, as opposed to such things as the credit ratings associated with the assets.” Translation: “We need to Americanize Basel.” Tarullo’s apparently feels that what is good for other banks, is not so good for banks here in the U.S. Why this reaction? Hong Kong, for example, is miles ahead on Basel adoption. It is finishing, just as America is getting around to starting. Of course, there’s Dodd-Frank, which needs to be adopted first, and that requires a reduction in reliance on credit ratings agencies for risk-assessment. “The banking agencies thus need to develop substitutes for agency ratings in each of the quite different contexts within the capital standards where they are used,” he said. “This has not been the easiest of tasks, but I believe we are now close to convergence on the approaches we will take in fashioning these substitutes.” In Europe, the reduction in reliance on credit ratings is manifest by using other firms to assess risk. In America, the Fed expects banks to take that in-house, which is somehow considered preferable. After all, banks prove to be exceptional at self-regulation. I’m not the biggest fan of Basel, to be clear. I’m actually prone to regulation bashing, not because of what it seeks to accomplish, but rather the peripheral damage. And this is the final point the Federal Reserve appears to disregard. Transforming Basel to comply with Dodd-Frank sends a message to potential investors overseas. It tells them that not all standards are created equal and some are better than others. Government-led fragmentation makes reform difficult to properly implement and send signals of market divisions in a blow to confidence. Tarullo may seek to tell lawyers that he’ll have something for them to look over in the first quarter of 2012. But, he is also sending up warning flares. For one, the fundamental responsibility of Basel to is to protect banks from failing. This is based on the theory that such an event would hold greater negative impact on a system-wide scale. Dodd-Frank’s main goal is ultimately to serve the average American. It is written to reduce taxpayer burden and offers consumer protection. Instinctively, the two seem to be at odds. Dodd-Frank is designed for orderly liquidation, Basel to prevent it. The former is meant to smooth the transition of the economy from boom to bust. Basel, as we’ve seen, actually accelerates the descent. Granted, we have yet to see Dodd-Frank in a boom-to-bust scenario. Yet, reason serves it should be one regulation or the other. Tarullo clearly believes that isn’t the case and sees a solution in the Americanization of Basel. And yet, later on there appears to be a contradiction in claims. “It goes without saying that the benefits of international regulatory rules will be realized only if they are implemented rigorously and consistently across jurisdictions,” he said. But the Fed just said they were changing Basel requirements to better reflect the needs of American financial institutions. Taking this with the above comments means that we can expect the benefits of these rules to go unrealized. I applaud Tarullo for taking on the implementation of robust regulations. And I fear even more for what those regulations will finally look like. Write to Jacob Gaffney. Follow him on Twitter @jacobgaffney.