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October 23, 2011 11:11 pm
In university economics exams, the old joke runs, the questions always remain the same – it is just the answers that change. Charles Goodhart, in his new history of the Basel committee’s early years, claims the same is true of regulation.
Many of the problems that led to the Basel Committee on Banking Supervision’s creation and to its growth in influence still haunt officials. Mr Goodhart’s book covers the period from the committee’s founding in 1974 to 1997, when Basel II dominated proceedings. It describes regulators’ travails in trying – and failing – to create early warning systems and resolution regimes for international banks. Both remain preoccupations today. Officials may have neglected liquidity regulation before the crisis, but it was discussed in the first papers circulated to the committee.
More than 600 pages long, the book is a thorough – in places microscopic – account of the committee’s first 23 years. It is not for a broad audience. But for anyone looking for insight into the workings of the committee or of regulators in general, it is invaluable. As the author notes, the crisis has underlined the topic’s wider importance.
The committee is best known for setting a global standard on how much capital banks should hold. The original capital requirement, which later became known as Basel I, is a case study in how regulation is set. Though the committee’s years of groundwork played a supporting role, it is clear that agreement would not have been reached without the political will of the big players – in this case the US and the UK. In contrast, despite the committee’s efforts, with external pressure lacking, progress on global liquidity standards stalled.
Basel I had also floundered until a dinner between Paul Volcker, then Federal Reserve chairman, and Robin Leigh-Pemberton, then governor of the Bank of England, held at the governor’s private flat in September 1986, in which the UK agreed to push for an accord. The Bank recognised that, with the Big Bang of financial deregulation approaching, the “gentlemanly” way in which it had previously regulated the City was no longer fit for purpose. Nigel Lawson, chancellor at the time, was threatening to remove its supervisory remit altogether.
The US had, up until that point, been Basel I’s most vocal proponent. With the Latin American crisis hitting US banks hardest, Congress was adamant that capital ratios would be ramped up for big international lenders. The US banks, predictably, lobbied for international lenders to be hit with similarly stringent requirements.
Though there was considerable anger at the “arrogant” US and “perfidious” UK, Mr Goodhart writes, Basel I “immediately became a standard to which all countries and major banks aspired, to an extent not previously expected by the Committee.” The committee’s membership was then limited to Europe, North America and Japan. But supervisors and banks the world over were “embarrassingly keen” to apply the new standard, even though it was meant only for big international lenders, due to the credibility attached to doing so.
How times change. The US never implemented Basel II. Jamie Dimon, chief executive of JPMorgan Chase, considers its successor “blatantly anti-American”. In Europe, there is much wrangling over European Union commissioner Michel Barnier’s insistence that national regulation does not go beyond Basel III – contrary to the spirit of the original agreement and its successor, which were always seen as minimum standards that national regulators could, and did, go beyond.
This is largely because Basel III is far tougher than Basel I. The new capital requirements are far more stringent (especially for big international lenders), and the framework demands banks hold more liquid assets. The answers have indeed changed – and this owes much to the increasing politicisation of financial regulation.
The Basel Committee – answerable to the G10 group of central bank governors, who in turn are accountable to their parliaments – was always politicised. But until 1983 there was, according to Mr Goodhart, “virtually no interference”. That changed somewhat after the Latin American debt crisis. Today, with taxpayers furious over banking bail-outs, the committee is no longer “primarily a self-starter”; it is the Group of 20, made up of heads of state, that sets the agenda.
Regulators failed “to see the systemic wood from the individually risky trees”, Mr Goodhart says, partly because they failed to appreciate financial economists such as himself. There may well now be a shift in the balance of power, from regulators focused on detail, towards financial economists. One hopes they will find better answers to the old questions.
The author writes for the FT’s Money Supply blog and economics team
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