A new chapter in regulation: Basel IV

Thursday, December 7, Frankfurt: a new agreement regarding financial regulation saw the light of day. This agreement is called Basel IV, and leads to higher capital requirements. To meet the international wish to reduce the banks’ freedom to calculate risks by themselves, as there have been some manipulations in the past.

To refresh your memory, why regulation is needed: it is important that there are stable and sustainable structures for the economy. This includes measures such as minimum capital requirements or deposit insurance to ensure that investors, as well as depositors, believe in the resilience of the banking system. Back in the days, some problems arose: on the one hand, the differences in accounting treatment led to distortion of competition. On the other hand, the volume of off-balance sheet transactions increased (swaps, derivatives, etc.). This led to the creation of a committee for banking supervision at the Bank for International Settlements (BIS), in Basel, and the first step towards an international standard for risk-adjusted minimum equity capital requirements.

Would they have ever expected that their BIS Accord from 1988, now also known as Basel I, would get several sequels? Did George Lucas expect there would be about 10 Star Wars movies? I guess not.

Almost 30 years after part I, and 10 years after the financial crisis of 2007-2008, Basel IV is there. European banks resisted the most against the measures; the measures would be disproportionately heavy for bank with a lot of mortgages on their balance sheet. European, and especially Dutch banks are large in mortgages. US banks, for example, can sell their mortgages immediately to a state institution. Furthermore, Basel IV sees no differences between a bank with only Italian mortgages and one with Dutch mortgages. Decent banks will undergo heavier consequences of Basel IV and, ironically, the Italian banks do not. The Dutch banks, for instance, need €14 billion more Tier 1 capital (e.g., stock). This might seem shocking, but they have until 2027 to get there.

The most important thing is that for banks, the uncertainty about capital requirements for their products, such as mortgages or SME-loans, has come to an end. Now it is finally possible again to make long term plans. The ING and ABN AMRO stock prices reacted with a nice plus on Friday morning.

Basel IV solves some minor issues without tackling the biggest problems. Now it is time to talk about the Southern European banks that are full of their own government bonds with zero risk weight... To end it with a positive note: we should not forget that regulation is to keep a stable and sustainable economy and to prevent crises, so this should be a good thing. We are getting there, step by step. I am already looking forward to Basel V.