Basel reforms reveal shortcomings of international standard-setting process

By Hugh Carney and Hu Benton
ABA Viewpoint

The turmoil that led to bank closures earlier this year has receded, and top regulators have declared our banking system strong and well capitalized. All 23 of the larger institutions subjected to recent stress tests to determine their ability to withstand severe economic conditions passed those tests and the Federal Reserve declared them “well positioned to weather a severe recession.”

Despite these seemingly positive signs, federal regulators remain determined to push forward their preexisting agendas, using the bank failures as a fig leaf. The most concerning of these is the so-called “Basel III endgame reforms” — a proposal that is particularly ill-suited to the problem regulators claim it will solve, and one that would have painful implications for banks of all sizes and for the economy. Moreover, their lack of alignment with current financial market risks is a reminder of the shortcomings of the international standard setting process. While we don’t yet know the full details of what the proposal will entail, FDIC Chairman Martin Gruenberg recently offered a preview, and we may learn more details as soon as Monday from Fed Vice Chairman for Supervision Michael Barr.

“Basel III endgame” is the term that regulators use for the next round of regulatory capital reforms developed by the Basel Committee on Banking Supervision, an international consortium of central bankers. But don’t be disarmed by the name, which allows regulators to frame what is a fundamental overhaul of capital requirements as a tweak of existing rules. These changes should more appropriately be called “Basel IV,” given the substantial impact they would have on the banking system.

Besides being misleading about the scope of the reforms, the name also reveals how dated the upcoming reforms are. Basel IV has been in development for over a decade and is a package of a dozen Basel proposals that focus on trading risk, operational risk, and credit risk. Their silence on liquidity or interest rate risk — the key factors in the failures of Silicon Valley Bank, Signature Bank and First Republic Bank — highlights the disconnect with current concerns. While the apparent decision to move forward with an international standard does not address these current issues, it does reveal much about the messy business of international standard setting.

Global cooperation on financial regulatory issues can be valuable and important. When these global exercises stray into creating standards accorded the force of law through implementing rules and regulations that are binding on U.S. firms and their customers, serious problems of accountability and transparency arise. The participation of U.S. regulators in the work of these global groups should be conducted within a framework more consistent with U.S. law and subject to full congressional oversight and public review. That isn’t happening here.

The concern, which has been periodically the focus of congressional inquiry, is that U.S. regulators have agreed to these standards without the normal legislative review applied to treaties or trade agreements. Moreover, these standards are developed in a murky international process that does not offer the safeguards and transparency provided in domestic rulemakings by the Administrative Procedure Act. While the follow-on regulations may be subject to public comment, by that time regulators have already made up their minds and committed themselves to the global blueprint, and the public comment process is little more than a formality. Yet despite these shortcomings, international bodies are effectively setting U.S. domestic policy affecting our entire financial system.

It’s inappropriate to ask American consumers and businesses to simply rely on regulators’ assurances about the future — particularly when they’re being asked to accept new standards developed by an entity far removed from our financial system. Policymakers have not yet shown that the benefits will outweigh the significant costs to the U.S. economy, and ABA and our members will take the necessary time to closely review the proposed Basel IV rule in detail to ensure that any potential reforms are both necessary and justified.

The sudden and misplaced focus on Basel IV highlights the broader importance of revisiting how U.S. financial regulators interact with international bodies. An essential first step would be to require that our financial regulators provide notice and comment before an international standards negotiation gets underway. This can be done by requiring regulators to clearly present for public review as well as oversight by Congress the substance and potential scope of a nascent international standard using an advance notice of proposed rulemaking or a request for information — an important transparency and accountability process that is already part of U.S. administrative procedure. These information gathering steps would allow for broad public input and consensus building on the clearly outlined goals of the discussion. The ANPR or RFI would include a clear statement of the problem or issue to be addressed, the potential avenues for addressing the issue, and the impact of the various approaches on the U.S. economy, on financial institutions and on their customers.

Some international bodies, such as the Basel Committee, do issue proposals for some degree of comment, but these efforts often come relatively late in the process after the substance of the proposal has taken shape. Moreover, because the discussions usually take place outside of the United States and are usually described as intended to affect institutions that compete at the global level, the vast majority of U.S. banks, and the American public in general, are insufficiently aware of the international proposals and do not typically participate in any international comment process. Neither does it appear that Congress is brought actively into the process before U.S. regulators take up implementation of the international agreement. In most instances, the cake is already baked.

As U.S. regulators prepare to discuss developing standards they should be transparent about to whom and how the standard could apply domestically, and that understanding should be shared with affected banks, their customers and the public. Use of the ANPR process would alert the public that an international body is considering new standards, offering the public the critical opportunity to raise important issues publicly with both the U.S. regulators and the international standard setter before global negotiations narrow the options and coalesce around suboptimal approaches that are forced upon the U.S. economy.

Unfortunately, the international standards about to be forced on U.S. banks don’t include any of those protections and safeguards. Our members are being told to simply accept the wisdom of the international Basel process and the higher capital and other requirements mandated by it. In our democratic system, that’s not how any regulated entity should be treated. We can and should do better.

Hugh Carney is SVP for prudential regulation and asset management at ABA. He previously served as a senior attorney for the Office of the Comptroller of the Currency. Hu Benton is SVP and policy counsel for prudential regulation and asset management at ABA.