Basel III Gutted, Delayed As Even Existing Regulatory Regime Too Burdensome For An Insolvent Banking Industry

In light of recent bombastic statements by priests of Keynesian fundamentalism that European banking is one big, non-dysfunctional, even healthy family, it would have been the logical thing that the Basel Committee on Banking Supervision would if not tighten terms on proposed Basel III implementation, then at least keep them as is. Why is why news that the recently proposed adjustments to Basel III which not only delayed implementation of the "regulatory" framework by many years, allowing banks sufficient time to blow themselves up under the current regime, but also to soften liquidity requirements of all global banks, is merely an indication that global regulators realize that the last free for all, in which every bank is allowed to steal as much as it possibly can before all hell breaks loose, in many times with as little as a penny in the mythical risk reserve concept known as Tier 1 Capital, levered a few hundred billion times, is finally here. And yes, aside from the fact that even the existing massively lax regulatory rules of Basel II need to be toned down is irrelevant: all European banks are healthy dammit, and just like in the US, bank failures will continue until credibility returns.

Bank of America's Richard Thomas explains why the latest (and worst) Basel III rewrite is extremely bullish: "some of the excessively sharp exclusions or rules have been softened and the implementation periods now appear to be more sensible, in our view – up to 7 or 8 years away." In other words the global banking regulators have given their blessing that the ponzi make believe world can exist another 8 years. Of course, the end will come long before then.

The Basel Committee published what we see as a very bullish update of its December 2009 proposals for capital and liquidity last night (Monday). We think it’s bullish because some of the excessively sharp exclusions or rules have been softened and the implementation periods now appear to be more sensible, in our view – up to 7 or 8 years away. Investors should stop worrying about the impact of e.g. the NSFR on senior issuance, in our view. Together with the CEBS stress tests, we view these developments as very bullish.

  • Very positively, in our view, the Committee recognised that the introduction of the NSFR (Net Stable Funding Ratio) needed to be recalibrated. Adjustments under consideration – most importantly, in our view – include an observation period to address any unintended consequences before the NSFR is introduced as a minimum standard by 1 Jan 2018, which we think is a very sensible time frame for the banks. Previously, investors had worried about an accelerated implementation (e.g. by 2012).
  • There was no change to the outline of what might qualify as Tier 1 securities under the Annex that we have seen, meaning that – as expected – ‘new’ Tier 1 is likely to have many of the characteristics that we originally saw in the proposals (e.g., explicit loss absorption etc.). There is nothing on what the new level of core Tier 1 will be, not of the new level of total Tier 1. However, minority interests will now be allowed, though not if the parent is funding the subsidiary. We’d guess that there will be at least a 7-8 year period for grandfathering. Not that bullish for calls, in our view.
  • Some deferred tax assets are now allowed, though not if these exceed 15% of the common equity component of Tier 1 (together with mortgage servicing rights and significant investments in unconsolidated financial institutions).
  • The leverage ratio stays and it will be a minimum 3%. Netting permitted. Monitoring until Jan 2011; parallel run period from Jan 2013 to Jan 2017; disclosure from Jan 2015. Final implementation 1 Jan 2018.
  • The Committee has developed proposals for contingent capital. These aren’t specified in the Annex. There will be more consultations on this. There are proposals to treat contingent capital as buffer capital which should be fleshed out by Dec 2010.
  • For the Liquidity Coverage Ratio, there appears to be greater flexibility with respect to definitions of qualifying liquid assets. There will be a Level 2 pool in addition to the core pool which, with a 15% haircut, can be up to 40% of the stock of liquid assets. Such much qualify for 20% RWA treatment under standardised Basel 2 treatment. They may include non-financial corporate and covered bonds, always with a 15% haircut. For those banks like the Australians that don’t have access to sufficient Level 1 assets, the Committee will develop additional standards.

As to specific examples of what regressive regulation in the aftermath of the biggest banking system collapse, here are some direct example from the annex filed by the Basel committee on fraudulent and corrupt regulation yesterday:

First, a discussion on the global liquidity (and lack thereof, except when backstopped by central banks the world throughout):

Liquidity coverage ratio (LCR)

Governors and Heads of Supervision also agreed on the Basel Committee’s concrete proposals to recalibrate the stress scenarios to achieve a conservative bank level and plausibly severe system wide shock. The Committee also made revisions to the definition of qualifying liquid assets subject to the overall requirement that such assets remain prudently liquid in periods of stress. The goal is to achieve a calibration and definition that penalises imprudent liquidity profiles, while minimising system level distortions. Specifically, Governors and Heads of Supervision endorsed the Committee’s following revisions to the December proposal. The Committee will review the impact of these changes to ensure that they deliver a rigorous overall liquidity standard.

  • Retail and SME deposits: Lower the run-off rate floors to 5% (stable) and 10% (less stable), respectively (from 7.5% and 15%). These numbers are floors and jurisdictions are expected to develop additional buckets with higher run-off rates as necessary.
  • Operational activities with financial institution counterparties: Introduce a 25% outflow bucket for custody and clearing and settlement activities, as well as selected cash management activities. These activities will be clearly defined in the final rule and would require specific supervisory approval before the funds specifically related to those activities could be considered “operational” (ie not all funds from the counterparty would qualify). The bank that has deposited the operational deposits would receive a 0% inflow recognition for those deposits, as those funds would be expected to remain at the other bank during a time of stress. The Committee also is in the process of discussing the treatment of cooperative and savings bank networks and will provide a concrete proposal for consideration at the September 2010 BCBS meeting.
  • Deposits from domestic sovereigns, central banks, and public sector entities (PSEs):
  • For unsecured funding, treat all (both domestic and foreign) sovereigns, central banks and PSEs as corporates (ie with a 75% roll-off rate), rather than as financial institutions with a 100% roll-off rate.
    For secured funding backed by assets that would not be included in the stock of liquid assets, assume a 25% roll-off of funding.
  • Secured funding: Only recognise roll-over of transactions backed by liquidity buffer eligible assets.
  • Undrawn commitments: Lower retail and SME credit lines from 10% to 5%. Treat sovereigns, central banks, and PSEs similar to non-financial corporates, with a 10% run-off for credit lines and a 100% run-off for liquidity lines.
  • Inflows: Rather than leave it to bank discretion to determine the percentage of “planned” net inflows, establish a concrete harmonised treatment in the standard that reflects supervisory assumptions.
  • Definition of liquid assets: All assets in the liquidity pool must be managed as part of that pool and are subject to operational requirements. The December 2009 proposal outlined that the assets must be available for the treasurer of the bank, unencumbered, and freely available to group entities. The Committee will finalise these operational requirements by the end of this year.
  • As part of the narrow definition of liquid assets, allow the inclusion of domestic sovereign debt for non-0% risk weighted sovereigns, issued in foreign currency, to the extent that this currency matches the currency needs of the bank’s operations in that jurisdiction.
  • Introduce a “Level 2” of liquid assets with a cap that allows up to 40% of the stock to be made up of these assets.
  • Include (with a 15% haircut) government and PSE assets qualifying for the 20% risk weighting under Basel II’s standardised approach for credit risk, as well as high quality non-financial corporate and covered bonds not issued by the bank itself (eg rated AA- and above), also with a 15% haircut.
  • Utilise both ratings and additional criteria as outlined in the December proposal (bid-ask spreads, price volatility, etc) to determine eligibility.
  • Develop standards for review at the September 2010 BCBS meeting for jurisdictions which do not have sufficient Level 1 assets to meet the standard.

So in addition to adding sovereign debt as perfectly liquid assets, which of course is perfectly logical in a world in which 5 MM in Greek CDS can move the spread by 100 bps, the Baselites are also largely destroying any prudent funding for existing underwater assets.

  • Retail and SME deposits: Raise the Available Stable Funding (ASF) factor for stable and less stable retail and SME deposits from 85% and 70% to 90% and 80%, respectively.
  • Mortgages: Lower the Required Stable Funding (RSF) factor to 65% (from 100%) for residential mortgages and other loans that would qualify for the 35% or better risk weight under Basel II’s standardised approach for credit risk.
  • Commitments: Lower the extent to which off-balance sheet commitments would need to be pre-funded, by lowering the previous requirement of 10% stable funding to 5% RSF.

And just in case there is any confusion which way the BIS' interests are aligned, all this "prudent" regulation will take about 8 years to be implemented, leaving banks more than enough time to implode on their own under the current, suddenly more stringent, regime.

Transition: Carry out an “observation phase” to address any unintended consequences across business models or funding structures before finalising and introducing the revised NSFR as a minimum standard by 1 January 2018.

All in all, just a day in the life of all those who job is to extend and pretend the viability of the Keynesian nightmare for a few more days, weeks and months.