On July 2, 2013, the Board of Governors of the Fed issued
final capital rules for banks implementing both the Basel III Capital Framework and certain additional requirements imposed by the Dodd-Frank Act. On July 17, 2013, the EU's
Capital Requirements Directive IV (CRD IV), which transposes Basel III into the EU legal framework, entered into force. While neither the US nor EU regulations follow Basel III to the letter, both sets of regulations move from using capital as the sole prudential reference, to multifaceted regulation and supervision employing capital, liquidity, and leverage ratios as contemplated by Basel III.
Each set of regulations actually goes a bit further than Basel III standards, with the US including, among other things a higher leverage ratio for financial institutions the Fed feels are systematically important, higher capital conservation buffers, the inclusion of off-balance sheet items in asset calculations, and the requirement to retain current risk weightings on mortgages. Like the US, the EU regulations also add a supervisory option for a buffer on systemically important institutions. CRD IV also provides for a each member state to introduce a Systemic Risk Buffer of Common Equity Tier 1 for the financial sector (or subsets of the sector), in order to prevent and mitigate long term non-cyclical systemic or macro-prudential risks with the potential of serious negative consequences to the financial system and the real economy in a specific member state. CRD IV also goes beyond Basel III and introduces improvements to the transparency of activities of banks and investment funds in different countries, in particular as regards profits, taxes and subsidies in different jurisdictions. In addition, CRD IV adds a host of governance standards, including standards for executive compensation and bonuses, board oversight of risk, and even board diversity.
Though financial institutions have been bracing for Basel III implementation since 2010, the banking industry finds these new regulations a bitter pill. The American Bankers Association voiced its concern that the full effects of Basel III standards, both intentional and unintentional, are yet to be felt.
Basel III exists because Basel I and II didn’t get it right. For that reason, we shouldn’t expect this rule to be perfect either – it’s clear that more needs to be done. While each iteration brings us closer to optimal capital rules, we won’t know if we’ve achieved that goal without having a much more thorough understanding of Basel III’s real-world impact.
The differences in the contours of EU and US Basel III implementation illustrate that global adoption of the standards will not be uniform, thus opening the opportunity for regulatory arbitrage. The EU is taking the prospect seriously, but believes that the risk of regulatory arbitrage is short-term and far outweighed by the benefits of global adoption of standards.
While there is always a short term risk of regulatory arbitrage if one jurisdiction goes further than other jurisdictions, in the longer term it is clearly beneficial as market participants benefit from a stable, safe and sound financial system. Even so, there may be areas where an international level playing field is more important also in the short run (e.g. the new elements of Basel III). The Commission is therefore closely monitoring the consistent and faithful implementation of the pillars of Basel III (i.e. capital, liquidity and leverage requirements) across the globe and would need to draw all the necessary conclusions in due time should other key jurisdictions not follow suit.