THE AGREEMENT by central bankers and financial regulators from 27 countries to raise the amount of capital that banks must hold against losses is welcome. Two years after the fall of Lehman Brothers, which precipitated the worst financial crisis in decades, major reform of international banking rules and standards has been overdue.
Although the various accords agreed by the Basel Committee on Banking Supervision since 1988 are not formal treaties, most countries with large banking sectors have followed the committee’s lead. Irish banks and building societies are already required to increase their capital reserves by year-end as a result of a review last March by the Central Bank and Financial Regulator. And because the capital ratios proposed in the current – Basel III – reforms are similar to those already introduced here, the domestic banks face no extra demands in meeting the new global banking standards. However, they are important from a global perspective.
In banking, capital acts as a buffer against risk where the assets of a bank decline or its liabilities increase. A bank without adequate capital reserves is badly placed to withstand substantial loan losses which may wipe out its shareholders as happened with Anglo Irish Bank. Likewise, low reserves may ultimately prove insufficient to protect depositors against losses unless these are guaranteed by government.
The global financial crisis, in revealing the inadequacy of existing banking rules, underlined the need for major changes in how banks operate. In that regard, Basel III attempts to strike a balance between ensuring banks – on one hand – are at less risk of failure and the financial system is safer while – on the other – the reforms do not result in slower economic growth with less credit available at a higher cost.
That is a difficult balance to strike. But the eight year transition period for banks to meet the higher capital adequacy ratios is longer than originally proposed and should make compliance easier. That said, the Basel committee wants very large banks of systemic importance to have a greater loss-absorbing capacity.
What Basel III has proposed is necessary but is it sufficient? The accord should help produce a more stable global banking system where institutions are less likely to engage in excessive and reckless risk-taking and are better equipped to absorb losses. But further reforms are required to ensure banks are fully equipped to withstand major financial shocks.