We’re finally seeing what the Financial Reform Act produced.
One of the little-noticed tenets of the Financial Reform Act was that it gave regulators the authority to implement the Basel III accords. Now we know what those accords specify, and it’s confusing.
Instead of simple, clear rules, we now have a 3 x 3 matrix of different types of capital, a five-tiered weighting of credit-risk, and a 20-year implementation schedule. The whole mechanism is supposed to reduce the risk of another global financial contagion by increasing the capital requirements on banks. It tries to do this in an intelligent manner phased in over time.
But the net effect of all this intelligence is increased complexity. The rules for risk-weighting the assets alone are mind-numbingly complex, with issues of control, credit agency certification, and what is or is not “sovereign” debt providing ample room for regulatory misinterpretation and regulatory arbitrage. In plain English that means that the bureaucrats will misapply the rules, and canny organizations will find ways to get around them. And we’ll all pay the price during the next crisis.
Thoreau once noted that as we simplify our lives, the laws of the universe will appear less complex. If we wanted a simpler, less complex banking system, Basel III doesn’t appear to be the way to go.
Douglas R. Tengdin, CFA
Chief Investment Officer
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