Basel dismisses banks’ claims that new rules will cut global output as over dramatic

News - Banking

Written by Ray Clancy

Thursday, 19 August 2010 09:29

New bank rules will cut global output only by a small fraction according to the Basel Committee on Banking Supervision and it is a modest price to pay for greater stability.

The influential body dismissed lenders’ warnings that the new Basel III rules for banks’ capital and liquidity may curb growth severely. It said they will tighten lending and reduce investment during a transition period, but to a much lower degree than forecast by banks.

Basel and the Financial Stability Board (FSB) said the banks’ assessment of the impact of the new rules was over dramatic because it assumed banks will return to pre-crisis levels for return on equity, and because it compared the impact to pre-crisis debt bubble practices that were unlikely to return even without new regulation.

‘Macroeconomic costs of implementing stronger standards are manageable while the longer-term benefits to financial stability and more stable economic growth are substantial,’ said Mario Draghi, chairman of the FSB.

Assuming the rules are phased in over four years and banks’ capital levels rise by 2%, output would on average decline by 0.38% compared to a baseline scenario, according to an analysis by the FSB, the body tasked by the G20 to coordinate a string of market reforms including Basel III.

This is only an eighth of the 3.1% output loss over five years due to Basel III and other measures which bank lobby group The Institute of International Finance (IIF) has predicted for the US, the euro zone and Japan.

The Bank of Canada said the new rules would benefit Canada’s economy significantly from reduced likelihood of fallout from foreign financial crises. It saw gains even with conservative benefit assumptions and the most extreme cost estimates.

Once banks have completed the switch, the new rules will help avoid or at least moderate the boom-and-bust cycles which first pump too much capital into the wrong places and then cause huge output losses when the bubble bursts, Basel said.

Eliminating savage downturns such as that seen after the 2008 financial crisis could in the long term add as much as 1.8%, Basel said in a second study trying to gauge the long-term benefits of the new rules.

‘Economic benefits of the proposed reforms are substantial and need to be considered alongside the analysis of the costs. These benefits result not only from a stronger banking system in the long run, but also from greater confidence in the stability of the financial system as soon as implementation starts,’ said Basel Chairman Nout Wellink.

The Basel Committee of global banking supervisors published a draft Basel III reform last December that would force banks to hold more and better quality capital to withstand future shocks without taxpayer help again.

It eased some of the original proposals and said banks would have more time to comply in a revision last month that addressed some concerns banks have raised.

The G20, which is spearheading the reform, is set to endorse the complete Basel III package in November with implementation starting from the end of 2012.

The Basel and FSB reports corroborate the view that a longer phase-in of the new rules is needed to avoid scuppering the fledgling recovery of the world economy, especially as major economies enter a period of budget austerity.

‘A longer transition period could substantially mitigate the impact, allowing banks additional time to adapt by retaining earnings, issuing equity, shifting liability composition and the like,’ the FSB said in its assessment of the transition.

While countries are broadly in agreement on the need for tougher guidelines, they are divided on the degree. Britain and the US have argued for a higher core Tier 1 ratio while Japan, France and Germany have pushed for less stringent rules.