Basel III, ECB and Explicit Bailouts of Governments

The Basel-accord are frequently paraphrased in the debate around banking stability and its third step, Basel III, is seen as a set of rules and regulations that once and for all will avoid future financial panic.  But as always, this can be interpreted as mere smoke screens to avoid financial system collapse now – but just postponing this unevitable event for later.

So whats the fuzz about?

Basel III in itself is rather straightforward. From bis.org:

Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector.”

Doesn’t it all sound just great? Banks getting more solid, regulations will increase and we will never experience another financial crisis!

Enough of the cynisism. This will happen through two distinctive legs – capital- and liquidity requirements. The liquidity side is put through as regulators believe that the financial panic of 2008-09 was caused and deepened by short-term funding shortages that “froze” the financial system and threatened to cause havoc among the world’s financial sector. The second leg aims to improve the sturdieness of banks by forcing them to hold more capital for each unit of loans outstanding.

This is all good, of course, as resilience to future losses in banks loan portfolios primarily are carried by equity holders and unsecured bondholders. The questions start arising when looking at how the regulations have been structured in order to accommodate for a few important stakeholders: governments and the current financial elite.

Basel III needs to be put into perspective. It needs to be analyzed – all the way from what counts as liquid assets to risk-weighted assets (RWA); ECBs best efforts to improve capital ratios through LTROs and comments from central bankers who see excessive risks in when what is perceived as risk-free can actually be deemed to be among the riskier assets out there.

This will take a number of blog posts. We will present the first part shortly, taking a deep dive into the capital requirement part of Basel III. We will then look into the liquidity requirements and then ECBs role into this and how central planners try to reach the goals outlined by the Basel Committee without having to take painful and “growth hampering” actions.

First part will come tomorrow.

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