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People and MarketsCommentGC View

Nationalist bank regulation from the US is the rule, not the exception

Proposals from US treasury secretary Steven Mnuchin to “advance American interests in international financial regulatory negotiations and meetings” are part of a long tradition in the country’s regulatory rule making — global norms are honoured more in the breach than the observance. At least now the US is willing to admit it.

Imagine there are no countries. It’s easy if you try, apparently. Not so much in banking regulation, where the power to lend money comes from the state, as does the ultimate backstop for the funds of depositors. But in recent decades, central bankers, regulators and the banks they supervise have had a good go, with a sincere attempt to set up global standards that banks have to meet.

The Basel Accords have been going since 1988, and have become immensely more complicated since then. They’ve also become far more important and interwoven into the fabric of finance, to the point where the chief executives of the most powerful financial firms are on tenterhooks waiting for a Delphic pronouncement on whether the capital cuts from using your own risk models should be limited to 30%, 27.5% or 25%.

Work on Basel standards of ever-increasing complexity coincided with increasing globalisation and financialisation over the last 30 years. Up until the financial crisis of 2007-2008 at least, the reach of global banks went further and further, trade flows increased, and more countries were drawn into the international capitalist economy. While central bankers discussed capital standards, their colleagues in trade policy discussed far reaching rounds of trade liberalisation through multilateral forums.

But US president Donald Trump put a stop to all that. Elected to “make America great again”, tear up NAFTA and show the globalists who is boss, the incoming Republicans started with a combative tone, instructing the US Federal Reserve to stop negotiating international agreements and dug in from there. Now the US Treasury has published a paper enshrining this approach to banks and markets, a mere day after another damp squib at the Basel Committee.

The funny thing, though, is that the Trump approach isn’t as different to Basel’s as it’s made out to be. The Basel Committee has never had any real teeth to enforce compliance. It grades countries and writes reports, but has no powers, other than causing embarrassment, to encourage members to take it seriously.

Not for US

So Basel has been ignored for much of its history, particularly by the US. The US never properly implemented Basel II, while the Committee’s big blockbuster crisis-prevention package, Basel III, has been totally overshadowed by the US Dodd-Frank rule.

The binding constraint on deploying capital at the major US banks is not the baroque risk-based capital framework painstakingly agreed by the global regulatory community, or even the Basel III leverage ratio, introduced as a backstop with US encouragement, but the Fed’s proprietary, secretive and challenging Comprehensive Capital Analysis and Review stress tests.

As for deploying capital internationally, forget it. Foreign banks with big operations in the US must set up an “intermediate holding company”, to make sure loss absorbing capacity and liquidity stays onshore. This flouts the delicate agreement reached on total loss-absorbing capacity (TLAC), drafted by the Financial Stability Board, another international regulatory body, which tried to balance the interests of home and host regulators for global banks. 

The banks themselves feel righteously penalised — a European universal bank might have a US book full of trading assets and leveraged lending, sending its US capital costs sky high, but appear much less risky when considered as a diversified group with lots of low risk European mortgage lending.

Lots of other countries are also willing to ignore global norms. Lobbying from German and Danish banks helped the EU turn a blind eye to the Basel Committee’s covered bond approach, and the fetishisation of small and medium enterprise lending in Europe turned into the “SME supporting factor”, a 25% capital cut which helped make sure that the EU is judged “materially non-compliant” by the Committee.

The EU is also considering its own version of the American intermediate holding company — an intermediate parent undertaking — which threatens to further fracture global regulatory cooperation.

The new US dispensation is less new than it appears, and, in admitting its nationalist agenda publicly, is refreshingly honest. If we can’t reach the world of regulatory cooperation, it is better to acknowledge it than try to dissemble. Perhaps it’s easier to imagine there’s no Basel.