Renegade EU’s Bank-Capital Pushback Threatens to Erode Basel

(Bloomberg) -- The European Union has threatened to go rogue in talks on bank capital rules, and the bloc’s willingness to go its own way could undermine global standards intended to avert a new financial crisis.

Top EU policy makers have made clear that sweeping changes are needed before the EU will accept a capital-rule revamp under way at the Basel Committee on Banking Supervision. The EU has a track record of doing its own thing: in 2014, the Basel Committee rebuked the bloc for failing to properly implement existing standards.

William Coen, the Basel Committee’s secretary general, is sticking to his guns. In Washington on Oct. 7, he made clear that key elements of the revised standards criticized by Europe will be retained, while indicating possible areas for compromise. Coen brings that message to Brussels this week, when he appears before the European Parliament.

“Europe is the least compliant of all jurisdictions in implementing Basel III,” said Nicolas Veron, a senior fellow at the Bruegel think tank in Brussels. “It’s entirely realistic that they won’t faithfully transpose all new standards,” he said. “The question is: Is it in the EU’s best interest to undermine the Basel Committee as the global standard-setter? Because that’s effectively what the EU is doing now.”

At the heart of the conflict are planned restrictions on how banks assess risk for regulatory purposes. The EU, home to nearly half of the world’s biggest banks, maintains the proposed changes would punish the bloc’s lenders and its economy. 

Valdis Dombrovskis, the EU’s financial-services chief, has identified a range of issues that need fixing, including planned restrictions on how banks use internal models to estimate risks from real-estate loans as well as corporate and infrastructure lending. A new capital floor, which caps the benefit banks can gain by measuring asset risk using their own models compared with a formula set by regulators, should be scrapped, he said.

Global ‘Disarray’

The Basel Committee’s members, including the European Central Bank, the U.S. Federal Reserve and Japan’s Financial Services Agency, have argued about the merits of allowing banks to model risk since the tool was introduced in Basel II a decade ago. Europe and Japan support the internal-model approach, while the U.S. has said regulators should consider discarding it because it creates the potential for banks to game the rules.

“The disarray in the global framework” reflects the “fact that Europe wants its banks to be de facto arms of the state,” while the U.S. and U.K. “want their banks to be de jure private companies that fail when they falter,” said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics. “A meaningful global regulatory framework that goes beyond platitudes is simply impossible given this fundamental divide.”

Capital Ratios

Coen’s appearance in the European Parliament on Oct. 12 may give him an opportunity to expand on issues where compromise may be possible. In Washington last week, he said the goal is to produce a “final package that reduces variability in risk-weighted assets and helps restore credibility to banks’ risk-based capital ratios.”

He’ll probably hear plenty from lawmakers who’ve had enough of ever-stricter rules on banks, which Europe relies on for the lion’s share of financing of the economy.

“There’s a broad consensus in the European Parliament that we shouldn’t overdo it with the new Basel standards,” said German lawmaker Markus Ferber. “It’s important to steer progress of the Basel talks in the right direction and to make sure that the proposals aren’t translated line by line into European law.”

That’s in line with the prevailing view among EU policy makers including German Finance Minister Wolfgang Schaeuble who have insisted that the Basel Committee not only keep any overall increase in capital requirements to a minimum, but also ensure the rules have no “particularly negative consequences for specific regions,” such as Europe.

‘Find a Balance’

“We are in favor of Basel III, but we think it is unhelpful, even dangerous, to want to add layer upon layer of obligations on banks, in particular on European banks,” French Finance Minister Michel Sapin told reporters on Monday in Luxembourg. “You have to find a balance between the security that’s needed” and “the financing of the economy, the financing of businesses,” he said.

Not everyone in Europe agrees.

“There have been high-level statements from Europe about ‘no more capital, no more capital,’ and I think they’re pushing in the wrong direction,” John Vickers, the chief architect of reforms that are remaking the U.K. banking industry, said last week. “We need to aim higher, not lower.”

Coen will hear dissenting voices in the European Parliament as well. Paul Tang, a Dutch lawmaker, said he’s concerned that European banks are “still fragile, still undercapitalized.”

Financial ‘Balkanization’

If Europe broke with Basel, it would lead to the “Balkanization of the financial sector,” Tang said. “I don’t think that the industry wants this in the end. I still think this is the normal noise toward the end of the Basel process.”

That view was echoed last week by Tim Adams, head of the Institute of International Finance. The global industry group has concerns about “fragmentation and a lack of coordination among financial regulators,” he said. “While it might be tempting to revert to exclusively local approaches to regulation, only global standards can lead to a level playing field.”

If the Basel Committee is considering pushing back the year-end deadline for finishing the new rules, as suggested by the International Monetary Fund, Coen didn’t mention it in Washington last week.

In the end, if no suitable deal can be reached, Europe won’t sweat it, according to ECB Governing Council member Ewald Nowotny.

“At the moment, we’re still very far apart,” Nowotny said on Oct. 5. “If we find an agreement, that’s good. If we don’t, we’ll be able to live with it as well. The process shouldn’t drag on forever.”

--With assistance from Silla Brush and Jonathan Stearns To contact the reporters on this story: Alexander Weber in Vienna at aweber45@bloomberg.net, Boris Groendahl in Vienna at bgroendahl@bloomberg.net. To contact the editors responsible for this story: Patrick Henry at phenry8@bloomberg.net, John Glover