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Basel III Won't Save Banks, Taxpayers, From Basel IV

By Alain Sherter

Updated on: September 13, 2010 / 3:09 PM EDT / MoneyWatch

The most salient aspect of the Basel III accord announced this weekend is the "III." Since 1988, global financial regulators have moved twice before to fortify banks against unforeseen losses. That we're onto the third round, this time after hundreds of banks around the world keeled over after being caught short of capital, tells you something about whether the latest effort will prevent future collapses.

As independent banking consultant and economist Ken Thomas told me, "Take three Basels and call me in the morning of the next crisis!"

The main problem with Basel III is that it focuses on supporting banks' profit margins rather than girding them against disaster. That emphasis is reflected in the agreement's modest scope. It phases in the new requirements over eight years, for instance, exposing the taxpayers who guarantee the solvency of large banks to risk.

More important, the pact doesn't dramatically raise the amount of money banks must hold. Basel III is unlikely to spur big U.S. institutions -- ground zero for the crisis -- to raise additional capital. Optimists might argue that this shows that American banks are already sound. I doubt it (see Citigroup). More likely it highlights how far regulators have gone over the years to accommodate banks' rose-colored accounting, which disguises their vulnerability.

European central bankers, in particular, appear content with such half-measures to bolster the financial system. Said Jean-Claude Trichet, president of the European Central Bank:

In the present episode of global recovery, after this shock we had in the previous years, uncertainty is the enemy in a way. With this decision ... we eliminate uncertainty in a large area which is a major contribution in consolidating the global economy.

Except that "uncertainty" isn't the only enemy -- so is certainty. We can be certain that over time banks will skirt whatever financial rules are formulated. We can be certain that when the next boom arrives regulators will relax their oversight of the industry. Vast quadrants of the financial world, especially the "shadow banking" system, will certainly continue to operate largely out of view. Also certain is that the "too big to fail" set will continue to lumber about, distorting competition and ensuring the necessity of bailouts.

While Wall Street and their European counterparts retain their same taste for risk, in other words, the accord makes the most reckless banks only marginally safer. Writes the WSJ's Alen Mattich in assessing Basel III's potential impact.

When the next accident happens to the industry -- and, because reform is superficial, while moral hazard has been reinforced, this will happen sooner rather than later -- governments and central banks will no longer be in a position to rescue the banks. The public will not stand for it and any effort to do so would undoubtedly be met with lynch parties.

But until then, savers and prudent investors will continue to be punished and bankers rewarded.

Stronger measures were never in the cards, however. The Basel committee's subservience to large banks aside, economic policy makers fear doing anything to crimp lending in an environment where it's already hard to get a loan.

Such concerns are overblown. Large banks are reeling in lending because of lower demand for credit and, to a lesser extent, higher underwriting standards. The prospect of higher capital thresholds, which have been talked about for years, has almost nothing to do with it.

Basel III is like a feebler version of the Dodd-Frank financial reform law: A politically expedient band-aid that fails to dress the deep wound defacing the banking system. See you at Basel IV.

Image from MorgueFile
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