For months, financial regulators from around the world have wrestled over a further tightening of capital rules for banks, the so-called Basel III reforms. Now Felix Hufeld, the head of Germany’s financial regulator and an important critic of the proposals to date, has given a speech in which he signaled a willingness to compromise.
For the first time, he has publicly accepted stricter rules on how banks calculate their risks and are thereby permitted to determine their capital needs. This is despite the fact that German banks could be especially hard hit by such a change.
Specifically, the proposal revolves around the extent to which banks will be allowed to reduce their capital requirements in the future by calculating their credit risks themselves. U.S. regulators, in particular, had called for a so-called lower limit, which determines how far lenders are permitted to deviate from a standardized approach.
A bank is required to back every loan with a sum of equity based on the default risk for the loan. This risk can be calculated using either a standardized approach or internal models.
The Germans, French and Japanese, in particular, had vehemently opposed the lower limit, also known as the output floor, fearing that their banks would then need significantly more capital for their business. German negotiators in the Basel Committee on Banking Supervision, the body responsible for global banking regulations in which the reform is being negotiated, had long insisted on dispensing with this output floor.
Mr. Hufeld now seems to have abandoned that position.
“It also is and remains my goal to bring Basel III to a successful end and find a sustainable global compromise.”
“We are now primarily concerned with the design and calibration of an output floor, which will limit variability in the use of internal models,” Mr. Hufeld, president of the German Federal Financial Supervisory Authority, known as BaFin, said Tuesday.
Mr. Hufeld’s signal is important. In a panel discussion in early November, he had threatened to block the reform because the proposals were “unacceptable” from a German standpoint. That view changed completely: On Tuesday, he also stressed that there would not be an agreement at any cost.
But he also emphasized his willingness to come to an agreement. “It also is and remains my goal to bring Basel III to a successful end and find a sustainable global compromise.”
There is a lot at stake with the controversial lower limits, because the banks’ internal models have fallen into disrepute in the aftermath of the 2008 financial crisis. The lenders are accused of having systematically downplayed risks with their models in order to save capital. The imposition of a lower limit means that the results of internal bank models can’t diverge from the standard method to an unlimited extent.
A 75-percent output floor, for example, would mean that a bank initially uses the standard method to determine how much capital it needs for a loan. After that, it can apply its internal method. But no matter which outcome the internal calculation yields, the bank calculation cannot be more than 25 percent lower than the standard method.
Just how high the output floor should end up being remains in dispute. A proposed compromise from early December, which introduced the 75-percent output floor, failed. Since then, the negotiators have been trying to find a solution, either by applying longer transition periods or by continuing to adjust the calculation method used in the standard approach.
Apparently the negotiations have been more successful than anticipated. A meeting scheduled for January 8 of the heads of key central banks and banking regulators, which was intended to give the reform its blessing, was postponed. Now Mr. Hufeld has made it clear that this was not a sign of discord.
“The meeting was postponed because final, but important, details still had to be clarified,” he said Tuesday.
Last week, sources close to the Basel banking committee said they were optimistic that an agreement would be reached in the first quarter of this year. The regulators likely have their sights set on a meeting of the finance ministers of the world’s 20 leading economies, the G20, in Baden-Baden on March 18.
It was the G20 that commissioned the reform of banking rules after the financial crisis. Now there is a good chance that the reform project will soon be completed.
Yasmin Osman is a financial editor with Handelsblatt’s banking team in Frankfurt. To contact the author: email@example.com