The Future of International Banking Regulation: A New Beginning or Business as Usual?

1. The Future of International Banking Regulation: A New Beginning or Business as Usual? Presentation at DIIS by Ranjitt Lall 18th of May 2010

2. Basel Accords • • Set minimum capital requirements for banks • • Capital (mainly equity) absorbs unexpected losses, but is costly for banks as a source of funding • Basel I (1988) • • Minimum capital requirements based on ratio of capital to risk-weighted assets of 8% • • Risk weights depend on riskiness of borrower e.g. government bonds (safe) 0% risk weight; corporate loans (riskier) 100% risk weight • • Provided opportunities for regulatory arbitrage, causing capital levels in the banking system to decline

3. Objectives for Basel II • To promote safety and soundness in the financial system • To continue to enhance competitive equality • To constitute a more comprehensive approach to addressing risks

5. the accord would have to introduce rules to capture three previously unregulated types of risks: trading book risks, in particular counterparty credit risk and risks related to over-the-counter (OTC) derivatives; market risk, the risk of losses to on- and off-balance sheet assets arising from movements in market prices; and securitization risks.

6. Impact of Basel II on capital levels • Large banks under A-IRB approach experience 26.7% decline in capital levels • Small banks under standardized approach experience 1.7% increase in capital levels • Consequence: overall capital levels fall (contra objective 1); large banks increase profits at expense of small banks (contra objective 2)

7. Mattli and Woods (2009): Regulatory Outcomes Institutional Supply Limited (Closed and exclusive forums, minimal transparency) Extensive (Proper due process, multiple access points) Narrow/ Limited Demand Broad/ Sustained

8. My ‘dynamic’ analytical framework • Mattli and Woods flawed: regulatory process takes place over time; some actors arrive before others • This is significant because of first-mover advantage: decisions made at an early stage are self-reinforcing • Who will arrive first? Those with the best information about the regulatory agenda; usually through personal contacts with regulators • Qualification: timing only important when agreements not subject to ‘ratification phase’

9. Applying my framework to Basel II • First-movers: large international banks represented by IIF • Second-movers: smaller banks and emerging market banks • Theoretical prediction: large banks will secure their preferred regulatory outcomes in Basel II

12. The G-20’s demands for capital adequacy reform • Washington Summit (Nov 2008): raise capital requirements for structured credit and securitization activities • BCBS response: trading book enhancements approved in July 2009 • Pittsburgh Summit (Sept 2009): introduce international leverage ratio, more restrictive definitions of capital, countercyclical capital buffers, capital surcharges for ‘systemically important’ institutions • BCBS response: preliminary proposals (‘Basel III’) released in December 2009; to be finalized by end-2010

13. Why Basel III will fail • Public attention to banking regulation decreases • Rule-making returns to BCBS, whose agreements do not require ratification by domestic stakeholders i.e. timing regains its significance • Large banks gain first-mover advantage through personal contacts with regulators

14. Strategies for first-movers in Basel III process • Using close personal networks to conduct private meetings with regulators: IIF Annual Conference (Oct 2009); World Economic Forum (Jan 2010) • Informational ‘scare tactics’: JP Morgan (Feb 2010); Project Oak (Apr 2010); BNP Paribas (Apr 2010)