Transatlantic Cooperation is Necessary for Global Financial Reform

By Rodrigo Sermeno, Transatlantic Economy Analyst


Recently, the Basel Committee on Banking Supervision agreed to increase the amount of top-tier capital that banks must hold in reserve.  The set of regulatory standards, known as Basel III, aims to prevent another credit crisis by addressing the deficiencies in global financial regulation.  Despite the different views on the type of regulation needed, global regulators agree that better financial regulation is essential to reduce the effects of global financial crises.  Developed countries account for the vast majority of capital raised in financial markets globally.  In 2010, the United States accounted for 32 percent of outstanding debt and equity worldwide and Western Europe accounted for 30 percent of the global total.  The implementation and enforcement by the United States and Europe is critical to the efficacy of the new regulations because of the larger size and greater complexity of their financial markets relative to other markets in the rest of the world.

The Basel Committee introduced Basel I in 1988, partially as a response to the actions by Japanese banks that appeared to be taking advantage of lower capital requirements.  In 2004, the Committee expanded the provisions under Basel II to revise some of the issues that had become apparent.  After the global financial crisis in 2007, regulators recognized the need to strengthen supervisory and regulatory measures under Basel II, based on the lessons learned from the crisis.  The most recent iteration of the Basel Accord aims at increasing the resilience of the global banking system by raising the quality, quantity and consistency of bank capital and liquidity.  Banks will hold Tier 1 capital under Basel III,which consists of equity or retained earnings, worth 4.5 percent of assets.  Banks will also have to create a new “capital conservation buffer” of equity totaling 2.5 percent of assets, which can be drawn upon in challenging times.  These two requirements will bring the total Tier 1 capital to 7 percent.  On top of the previous two requirements, the new regulation will require banks to build a separate “counter cyclical buffer” between zero and 2.5 percent during times of high growth in credit markets.


Critics of more banking regulation argue that the increase in capital requirements could hurt banks by reducing their assets.  According to these critics, the Basel rules qualify as over-regulation because it destroys the amount of money circulating in the economy and introduces distortions in credit markets.  The higher capital requirements in Basel III are not particularly popular among bankers because they reduce bank profits and thus many of them would like to see the accord toned down.  Charges have also emerged that the effect of Basel III would fall on European banks more heavily than US banks because European businesses rely more on banks for funding relative to capital market sources.  Standard & Poor’s calculates that borrowing costs in Europe will increase by between 30-50 billion euros per year after the Basel III gradually rolls out in 2013.  Furthermore, several European banks have voiced their doubts that the US banks will indeed implement the new measures.


In a move to shame big countries into implementing their commitments, the Basel Committee published a scorecard to evaluate the progress each one of its members has made in implementing the Basel standards.  So far, six of the 27 countries have not fully implemented the Basel II rules agreed in 2004, and only 11 of them have drafted rules to enact Basel III.  Nine of the 11 countries that have written drafts are members of the European Union, which introduced a EU-wide version a few months ago.  In contrast,the United States is among the countries that have not fully implemented Basel II.  However, US banks expect to complete the process by the end of this year.


The greatest issue with global financial regulation is the mistrust that invariably appears in situations that require cooperation among several parties.  It is not surprising for accusations coming from both sides of the Atlantic to emerge about either side’s unwillingness to fulfill their commitments. The problem of falling into this accusatory pattern is that it bogs down the process.  The United States and Europe must lead the G20 in implementing the Basel III rules, not only because of the importance of their financial markets to global financial stability, but because any serious reform of global financial rules cannot begin without the leadership of the US and Europe.  For Basel III not to meet the same fate as its predecessors, cooperation across the Atlantic is necessary.  This will determine whether the third time is the charm for actual progress on global financial rules.

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