TWN Info Service on Finance and Development
17 October 2011
Third World Network
Only modest growth slowdown from higher capital standards
Published in SUNS #7236 dated 11 October 2011
Geneva, 10 Oct (Kanaga Raja) - Raising capital requirements on the top
global systemically important banks (G-SIBs) is likely to lead to only
a modest slowdown in growth, while the benefits from reducing the risk
of damaging financial crises will be substantial.
This is the outcome of a joint assessment by the Macroeconomic Assessment
Group (MAG) of the Financial Stability Board (FSB) and the Basel Committee
on Banking Supervision (BCBS), released on 10 October.
The report, produced in collaboration with the International Monetary
Fund (IMF), assesses the macroeconomic costs and benefits of proposals
for higher loss absorbency for G-SIBs.
Taking all factors (including over- and under-assessments) into account,
the benefits of stronger capital standards are likely to be significantly
greater than the costs, the MAG report concludes.
[The MAG assessment and issuance of its outcome has come even as some
of the top US systemically important global banks are attempting to
pressure and browbeat the global regulators from enforcing the proposals
in Basel III for raising the capital requirements and risk calculation
[The Basel III capital rules are designed to make the financial system
safer by making banks build up risk-absorbent "core tier one"
capital to at least 7 per cent of risk-weighted assets, while G-SIBs
like JPMorgan Chase, have to reach 9.5 per cent. According to Yves Smith
at the "Naked Capitalism" blog, in agreeing on Basel III,
regulators of all countries compromised, to put eight banks (five from
outside the US)
in the top level of capital.
[Now, leading the pack in the campaign by Big Banks against increased
capital requirements has been Jamie Dimon, chief executive of JPMorgan
Chase, who said in an interview in the Financial Times (12 September)
that the new international bank capital rules are "anti-American"
and the US should consider pulling out of the Basel group of global
regulators. US regulators, he further argued, "should go there
and say: ‘If it's not in the interests of the United
States, we're not doing it'."
Mr. Dimon followed up on this a few days later, by launching what Yves
Smith has called "a tirade" at Mark Carney, Bank of Canada
governor, in a closed-door meeting in front of more than two dozen bankers
and finance officials. Mr Carney is being mentioned as a potential next
head of the Financial Stability Forum.
[In her post on the Dimon attacks, Yves Smith notes that during the
Dodd-Frank legislative process, US Treasury Secretary Timothy Geithner
said repeatedly that the shortcomings in the legislation didn't matter
all that much, since having banks carry larger capital buffers would
do the trick, and that was coming with Basel III. It is this, she says,
that Mr. Dimon was trying to undermine. If US banks want to play outside
America's borders, they should expect
to be subject to different rules.
[Within 48 hours of the Dimon tirade, she notes, Mr. Carney spoke to
the global bankers at the Institute of International Finance, warning
them that "it is hard to see how backsliding [on implementing new
capital rules] would help" the global economy. "If some institutions
feel pressure today, it is because they have done too little for too
long, rather than because they are being asked to do too much, too soon,"
he said, adding that authorities are increasingly hearing concerns about
the pitch of the playing field for Basel III implementation with "everyone
is claiming to be a boy scout while accusing others of juvenile delinquency."
However, the Canadian central banker added, "neither merit badges
nor detentions will be self-selected but, rather, determined by impartial
peer review and mutual oversight." -- SUNS]
Against this background, the MAG report (one of the documents that will
be before the G-20 finance officials and ministers in preparation for
the G20 summit next month in France), said the costs of the G-SIB proposals
stem from the adverse impact on economic activity, especially investment,
of banks' actions to increase interest rate spreads and cut lending
in order to build up their capital buffers.
The report finds that weaknesses at large, complex financial institutions
have historically been a central factor in triggering and propagating
systemic financial crises. Failures in risk assessment and risk management
at a small number of institutions can have large effects, disrupting
activity in many related institutions and many sectors of the economy.
The size and complexity of these institutions present a challenge for
public authorities. Rescuing such institutions through emergency loans
or capital injections can often be the only way to contain financial
crises and alleviate damage to the real economy in the short run, it
But, says the report, this comes at the cost of creating moral hazard
by encouraging institutions to resume their risky behaviour after the
crisis has passed. These patterns and dilemmas were especially prominent
during the global financial crisis of 2007-09.
The MAG estimated the impact of higher capital requirements on G-SIBs
by scaling the impact of raising capital requirements on the banking
system as a whole, reported by the MAG in 2010, by the share of G-SIBs
in domestic financial systems.
While these shares vary across jurisdictions, the share of the top 30
potential G-SIBs (using the Basel Committee's proposed methodology and
end-2009 data) averages about 30% of domestic lending and 38% of financial
system assets in the MAG economies.
Using lending shares as a scaling factor, the report finds that raising
capital requirements on the top 30 potential G-SIBs by 1 percentage
point over eight years leads to only a modest slowdown in growth. GDP
falls to a level 0.06% below its baseline forecast, followed by a recovery.
According to the report, this represents an additional drag on growth
of less than 0.01 percentage points per year during the phase-in period.
The primary driver of this macroeconomic impact is an increase of lending
spreads of 5-6 basis points.
Soon after implementation is complete, growth is forecast to be somewhat
faster than trend until GDP returns to its baseline, the MAG report
The report points out that the aggregate figures conceal significant
differences across countries, which reflect differences in the role
of G-SIBs in the domestic financial system and in current levels of
bank capital buffers. International spillovers are also important, and
in some countries are likely to be the dominant source of macroeconomic
"The overall results are robust to variations in key assumptions.
Using a longer list of banks, scaling by assets rather than lending,
shortening the implementation period, or limiting the ability of authorities
to offset slower growth with monetary or macro-prudential policy were
all found to increase the growth impact, but not markedly."
The overall impact of the Basel III proposals (which apply to all banks)
and the G-SIB framework is also quite small, with GDP at the point of
peak impact projected to be lower by 0.34% relative to its baseline
level. Roughly four one-hundredths of a percentage point (0.04%) are
subtracted from annual growth during this period, while lending spreads
rise by around 31 basis points, the report further says.
As before, it adds, different assumptions lead to different effects,
with faster implementation or a weaker monetary policy response increasing
the impact on GDP.
According to FSB-BCBS, the permanent benefits of the G-SIB framework
arise from the reduced likelihood of systemic crises that can have long-lasting
effects on the economy.
The MAG estimated that raising capital ratios on G-SIBs could produce
an annual benefit in the order of 0.5% of GDP, while the Basel III and
G-SIB proposals combined contribute an annual benefit of up to 2.5%
of GDP - many times the costs of the reforms in terms of temporarily
slower annual growth.
The report notes that as is the case with any economic analysis, producing
these estimates required making a number of assumptions. Some of these
can be imposed or removed as part of the estimation process. Other aspects
are more difficult to analyse.
For example, it says, the role of G-SIBs in the financial system, through
their status as market leaders or through their dominant positions in
certain activities, may be greater than is implied by their share in
lending or assets. In this case, the macroeconomic impact of their adjustment
to higher capital levels may be greater - although the benefits from
strengthening their balance sheets would be greater as well.
Conversely, a pull-back in activity by G-SIBs may have a relatively
mild impact if credit can be provided instead by smaller institutions
or capital markets; this would reduce the macroeconomic cost of the
stronger G-SIB requirements, but could also reduce the benefit from
reducing the risks of distress at a G-SIB.
The report acknowledges that more analysis is needed to understand these
It will also be important to engage in further study of the impact of
other elements of the FSB's broader framework for global systemically
important financial institutions (of which the Basel Committee's G-SIB
proposals form a part) as they are implemented, such as the proposal
that unsecured and uninsured creditors be "bailed in" at the
point of resolution, the MAG report concludes.
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