European Regulators Should Let Banks Bank

A 20 lev banknote sits in a change dish on a kiosk counter in Bulgaria. (Photographer: Jasper Juinen/Bloomberg)

European Regulators Should Let Banks Bank


There’s a conflict brewing in Europe between regulators, banks and some politicians over how new Basel III-compliant rules will be framed. Several banks, as well as policymakers in countries including France and Germany, say the capital requirements called for under the new regulations are too high. The Basel Committee on Banking Supervision thinks that these last-ditch efforts to weaken Basel III’s implementation, due to be phased in from 2023, are “highly unfortunate and extremely bad timing.”

This debate might seem easy to resolve: The regulators are right, surely? Not a lot was learned from the 2008 financial crisis, but one lesson was that higher capital requirements are a much-needed buffer. In this case, however, the regulators are wrong and the bankers are right — though not for the reasons you’d think.

European banks are worried that the new standards, which will increase capital requirements on average by 19%, will crimp lending. (German and Danish banks, which would need more than 35% extra capital, are particularly worried.) They also want to be able to use their own internal models for risk.

Regulators such as Francois Villeroy of the French central bank say that the fact that bank lending rose during the pandemic shows that lending won’t be hit. This is an odd argument, given that in spite of unprecedented central bank support, banks have tightened credit standards so much that Europe’s recovery is threatened. In the United States, too, the data shows that Treasury-bolstered loans under the Paycheck Protection Program are what’s driving lending growth.

Banks’ complaints about constraints on lending should be taken seriously. Good policy is made when decision-makers responsible for two sets of risks balance them out. The Basel Committee is tasked only with avoiding one set of risks, the macro-prudential sort. Its recommendations need to be re-examined by those who also recognize the threat that lower lending would pose — and who are responsible for the unintended consequences of excessively restrictive regulation.

Those consequences can be stark, and not just for Europe. Longer-maturity project financing, for example, has dried up thanks to post-2008 regulations, with dire consequences for infrastructure globally. Emerging countries such as India have been particularly hurt. Prior to 2008, European savers were helping boost emerging-market growth and getting a reasonable return for their effort. Since 2008, European savings have largely been stuck earning low — or negative — domestic returns, and developing nations have had to do without their help.

Private financing of infrastructure had collapsed even before the pandemic halved it to $46 billion. (It was about $200 billion in 2012.) When trans-national project finance did not cause the 2008 crisis, why did post-crisis regulations shut it down? Who should be held responsible for this unintended consequence of Basel III?

Clearly, the supervisors in Basel don’t care about such unintended consequences, nor do central bankers. It isn’t their job to care. But banks do and, if politicians care about savers, they should pay heed.

Generals fight the last war and regulators fight the last crisis. We are no longer living in a world endangered by gung-ho lending. Rather, it’s a world in which risk-taking is weighed down by enormous central bank balance sheets. It’s one that needs to get private finance lending again to crucial sectors such as infrastructure and climate resilience — particularly in developing countries.

A financial crisis doesn’t have to look exactly like 2008. When finance is consistently unable to provide yields for savers in developed markets and also failing to fund important and remunerative projects in the rest of the world, that’s also a crisis. By those measures, we’ve been in a financial crisis for years.

When French and German banks make a case against Basel III, they frame it in terms of their domestic competitiveness and their ability to lend to local business because that’s what might move European politicians. But that’s not the biggest danger that more restrictive banking regulations pose. The real concern is producing a financial sector that fails at its basic job: going out into the world and finding the best risk-return mix for clients.

If climate change-sensitive infrastructure is to be built across the emerging world, then it will need to be financed through entirely new and innovate mechanisms. But standardized models of risk, such as those that regulators want to force on European banks, penalize precisely those institutions that would seek out new markets and new asset classes.

Preventing another financial crisis is important. But it is too important to be left to regulators alone. European policy makers should listen to what their banks are telling them: The threat to the world today is not the same as in 2008. We need banks to have the ability to lend. To finance a global recovery, we need a more active financial sector, not one that is throttled by well-meant regulation.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mihir Swarup Sharma is a Bloomberg Opinion columnist. He is a senior fellow at the Observer Research Foundation in New Delhi and head of its Economy and Growth Programme. He is the author of "Restart: The Last Chance for the Indian Economy," and co-editor of "What the Economy Needs Now."

©2021 Bloomberg L.P.

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