Basel III Is Too Kind to Europe's Banks

(Bloomberg View) -- After years of talks, central banks and financial regulators have finally agreed on the Basel III rules for bank capital. That's a good thing, mostly. The deal improves the regulatory framework and will give banks greater clarity about what's required. It's also a timely reminder that international policy cooperation can work.

There's a catch, however: The new rules have been watered down. Since the financial crisis, the European Union has been less zealous than the U.S. about reform -- and the Basel committee has relaxed some of its proposals to get the EU on board.

Starting in the mid-1970s, the Basel process has enabled supervisors to share financial data and set international standards. The meetings are too secretive and would benefit from greater openness, but the resulting agreements have served a vital purpose in letting banks compete internationally on more equal terms.

Since the crash, the reforms have concentrated on raising bank capital -- a form of financing that can absorb losses if things go wrong. Before 2008, banks had too little. That was partly because they relied too much on internal models for judging the riskiness of their assets. Managers could use these models to economize on capital.

The new agreement limits this flexibility by requiring greater use of standardized models. European banks resisted the move, fearing they'd be hit hard while they struggle with low profitability and bad loans. To win them over, the committee made the standardized models' risk weights for certain assets, including some corporate and mortgage loans, lower than previously proposed. As a result, the European Banking Authority expects the new rules to have no great impact on EU banks' capital ratios.

That's a pity. It may leave some of Europe's banks -- and hence Europe's taxpayers -- at risk. The deal is still a notable achievement, because it puts a better system in place. But the compromise with Europe makes it only a qualified success.

--Editors: Ferdinando Giugliano, Clive Crook.

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