TWN Info Service on Finance and Development (Oct11/03)
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 methodology.
 
[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 adds.
 
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 said.
 
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 effects.
 
"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 effects fully.
 
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.