Opinion: Government must act to stop Basel reforms

Lichtkunst "Brillant par Tradition" in BaselMost of my working day is spent scuttling between sombre conferences on Central Banking best practice and meeting city economists to get their instant reaction to economic developments.

So when an opportunity came recently to travel to Basel in Switzerland to cover the latest announcement from the committee which aims to create a new framework for banking regulation, I leapt at the chance. But my delight at getting a free trip shouldn’t mask the fact that developments in the scenic Swiss city should be a cause of great concern for the government.

The latest proposals merely restore the status quo which led to the credit crunch.

The measures state that banks must hold liquid assets over a 30 day period of at least 60% of their anticipated net cash outflows.

But it’s not with this number that the problem arises.

Rather it’s the definition of ‘liquid assets’ which should be of concern.

The initial proposals from the Basel committee argued that only cash, government bonds and a limited range of corporate bonds should count as truly ‘liquid’ i.e. easily and quickly convertible into cash.

These assets have the advantage of being relatively ‘safe’ investments, but offering a comparatively low rate of return, and so risk thirsty banks do not wish to be overly exposed to them.

Since the initial proposals were announced, the major banks have delivered a massive lobbying operation. Now the proposals have been altered to allow certain company shares, a wider range of corporate bonds (including those with an official credit rating of as low as BBB) and most oddly of all, mortgage-backed securities, also to be seen as ‘liquid’ assets in the eyes of the Basel committee.

It was the fact that the financial system lost faith in the value of these mortgage-backed securities in 2008 that resulted in the credit crunch.

Banks won’t ever lose faith in cash, and sovereign debt will usually find a market.

But mortgage-backed securities are assets which are entirely reliant for their value on the housing market. The collapse of this market has arguably been responsible for most British recessions since the war. If these proposals are enacted, they would ensure that any future recession caused by falling house prices would be necessarily accompanied by a credit crunch, as banks would have to reduce their lending to comply with these rules. This would restrict the options available to the government of the day with regard to combating a recession.

Independent central banks are a vital component of the economy, as they can take decisions based entirely around the economic cycle rather than the electoral cycle. But a major problem is that central banks are staffed by people who have an inherent bias towards believing in the wizardry of the senior staff in the commercial banks, as they are likely to have studied at the same institutions and read the same books and garnered the same qualifications.

Governments should not however be blinded by any such belief. The latest proposals from the Basel committee are bad for banking, and bad for Britain. They should be resisted by all means available to the coalition.

* David Thorpe was the Liberal Democrat Prospective Parliamentary Candidate for East Ham in the 2015 General Election

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  • Good article. In essence, huge pressure from the banks on the Basel Committee on Banking Supervision (BCBS), to relax the rules of supervision, has worked. The banks and their (supine?), ‘supervisors’, have effectively ‘baked into the cake’, the next financial crash. It’s just a matter of time.
    But it seems that some of the smarter governments who have grasped this mad Basel flaw, are wisely hedging those high risk assets, with some low to zero risk assets.
    And :
    Don’t you sometimes wish, that our UK Coalition government were one of those smarter governments ?.

  • Mark Blackburn 21st Jan '13 - 3:27pm

    Don’t always (OK, often!) agree with you David but this is spot-on. The banking/financial sector remind me of the Terminator – doesn’t matter what you throw at it, it re-configures its damaged body and comes back at ya stronger than ever. Unfortunately it seems to have reached the point where global finance is more powerful than national sovereignty, and any financial regulatory agreement is only as strong as its weakest link. But Basel is so feeble anyway the financiers don’t even have to bother to find the weakest link.

  • David Thorpe 21st Jan '13 - 3:28pm

    @ Jon

    our givernment is taking the approach that it was a cycilical, rather than a structural problem-and so istn doing anything particualrly smart-also we cant repatriate our gold-Gordon Browqn sold most of it!

  • “….we can’t repatriate our gold-Gordon Brown sold most of it!”
    Absolutely David. And he apparently sold it very cheaply, and even announced when he was putting it on the market. No-one, (not even the queen), has quite got to the bottom of why he did that.?

  • David Thorpe 22nd Jan '13 - 3:02pm

    @ dave page-sharon bowles isnt particualrly relevant-though she can make noise I guess.
    I do think that Lib Demn Mp’s (any of them frankly) should be questioning these reform proposals in parliament

  • Dave,

    an interesting article as always.

    Although liquidity is an important element in restoring stability to the banking sector, ultimately it is capital adequacy that will determine banks ability to maintain market confidence.

    These days banks can access unlimited liquidity from their central banks as long as they are demonstrably solvent.

    The type of assets in which bank capital is invested and the risk-weighting that is attached to them will determine, to a high degree, the manner in which banks will meet their obligations to maintain liquid funds of at least 60% of their anticipated net 30 day cash outflows.

    If mortgage backed securities carry a significantly high-risk weighting as compared with less volatile assets such as sovereign debt that will impact the risk-management strategy of banks.

    The Vickers commission called for much higher capital ratios than the levels under the then Basel rules, as well as the ringfencing of retail banking. I would hope we see these proposals fully implmented in the coming financial regulation and banking bill.

  • Bill le Breton 23rd Jan '13 - 9:25am

    The valuation and the ‘risk’ of assets is largely dependent on aggregate demand. If central banks had ensured that aggregate demand returned as quickly as possible to pre-credit-crunch levels (as some did) and if they had even made up the shortfall in AD, the capital situation of commercial banks would be much more sound and of course their clients’ enterprises would be doing more business.

    Let’s have a globally orchestrated boost to aggregate demand and then see what the size of the remaining problem is.

  • david thorpe 23rd Jan '13 - 6:27pm

    @ bill le breton

    asset prices are in a bubble period now-thanks to QE-a global inititaive to boost aggregate demand!

  • Bill le Breton 24th Jan '13 - 8:28am

    David ‘asset prices’ are not a ‘bubble’ they are a price.

    As Scott Sumner has neatly put it, ‘Bank lending is not a causal factor—it mostly reflects the growth rate of NGDP.’

    UK NGDP (aggregate demand) has risen by just 2.5% since the start of Coalition economic policy. Expectations of NGDP growth are locked in at this low level, therefore viable investment projects are few …

    It was the policy of allowing aggregate demand to plunge in 2008 that destroyed bank capital at the same time as entrenching expectations of further falls/weak growth. We are now 15% down on the trend level. That’s a hell of a lot of demand/income

    Without QE that growth and therefore expected future growth would be even lower.

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