Basel III’ is Europe – Part I

Lots of twitter-folks, especially law shunning economists, have only a slight clue as to what the Basel III implementation in Europe actually entails.

So, here’s my briefings on Basel III. Note, I write this post as an economist, who, after a decade of academia subjected himself to five years of a regulators’ commitment to help beef up the rules for regulatory bank capital.

Over the next weeks I will post more on Basel III in Europe, to debunk some myths, and to focus on rules that deserve more attention.

The R in CRR stands for Regulation.

This is not well understood. For Basel III, the EU mainly uses its Regulation instrument, much like with IFRS, the international financial reporting standards. The Regulation instrument offers two distinct advantages.

Regulation protects EU citizens from local politicians. Unlike Directives, which member states transpose into national law and are used to add folklore to rules, Regulation comes straight from the EU. This gives the EU tight control over these subjects in particular: Regulatory Capital, Liquidity, Leverage, Counterparty Credit Risk, Large exposures, and the Basel III Disclosure requirements. These important topics, if left in the hands of individual member states, would lead to too many divergences that could potentially pose a threat to financial stability.

Luckily the Regulation offers flexibility. Few countries implement Basel III in full*. This also holds for the EU, including the EU countries present at the G20 of November 2010 who supported the new rules.

As reported by Basel’s regulatory consistency assessment of October 2012, Europe created its fair share of non-trivial departures from Basel III. Though EU Commissioner Barnier may disagree openly with the assessment, some departures expose blatant efforts to water down Basel III, as I will show in subsequent blog-postings.

The good thing about the EU’s Regulation instrument is that the departures can be undone. The EC can decide to change the regulation when needed. This is more efficient than changing a Directive that relies on individual EU countries to act as middlemen.

This is not to say that changes in Regulation can be made on the drop of a hat.  There is proper governance, e.g. the EC may consult the European Banking Authority on changes, and EBA relies on inputs from EU member states.

One example of a potential change in the making is the one on the regulatory treatment of unrealized gains. The European Commission has invited the European Banking Authority to advise on the exclusion of unrealized gains from regulatory capital, see my blog post from earlier this month on this Basel III departure .

My take-away: though you may comment on Europe’s Basel III implementation, I’m afraid you are about a whopping 5 years too late. Europe has already decided about the rules on bank capital.  (Actually it is more than 5 years too late to comment: the Basel committee started redefining the rules on capital at the start of 2007 – before the crisis took off.)

Next: CRD IV will come into force after only a one year delay, compared to the rules for insurance that is no small feat. How will the transition work?

* Hence the prime (‘) after Basel III in the title of this post.