International co-operation on banking reform is axiomatically desirable. We live in an era of massive global capital flows and sophisticated cross-border banking. A firm like HSBC takes deposits from ordinary savers in Hong Kong but is regulated in London. Goldman Sachs collects money from clients in Europe and invests it in China. In a world of globalised finance, it makes sense for national regulators to work together.
But an international approach is only really worthwhile if it is effective. And, sadly, the latest efforts of the Swiss-based Basel Committee on Banking Supervision, the closest institution we have to a global banking governor, simply do not come up to scratch.
The new capital adequacy rules unveiled by the committee yesterday, known as Basel III (after two other ill-fated incarnations), will require all banks to hold "common equity" of at least 7 per cent of their assets. This is considerably more than the 2 per cent core capital requirement under Basel II. But the new minimum is still less than the 11 per cent capital that Lehman Brothers was reporting right up until the Wall Street firm went bust two years ago. Some grossly undercapitalised European banks in Spain and Germany will have to raise more equity under Basel III. But they will have a generous six years to comply. And US and UK banks have already more or less reached the required capital ratios. Most banks will have surveyed what the Basel Committee produced yesterday and concluded that it was the green light for business as usual.
So how did it come to this? How, with the greatest banking meltdown since the Great Depression still fresh in the memory, did we get such weak reform? A big part of the answer is that the Basel forum itself is discredited. At Basel, central bankers and regulators effectively haggle with the representatives of the very industry they are supposed to be overseeing. And the banks lobbied very effectively indeed. Citing dubious statistics which purportedly showed that tough new capital rules would hold back the economic recovery, they succeeded in getting the requirements watered down to near uselessness.
The financial lobby also skilfully exploited the divisions between national governments over the level of capital needed by banks. Germany and some other EU governments are still in denial about how short of capital some of their own lenders are and fought efforts of the US and the UK to push for higher ratios. While national governments were divided, the banking lobby was impressively united.
This regulatory weakness is one of the reasons why it is so hard to take this reform seriously. There is scope under Basel III for regulators to force banks to raise their capital to 9.5 per cent of assets when the next credit boom begins. But all the evidence suggests that the banks will steamroller the regulators if they attempt to exercise these powers.
Similar scepticism ought to attend the new powers of regulators to force banks to cease paying bonuses and dividends if their capital dips below 7 per cent. We have seen the limits of the ability of politicians and regulators to force bankers to exercise restraint over remuneration all too clearly in recent years. There is no reason to believe that they will take a more robust stance in future.
Two types of reform were made necessary after the global financial meltdown. First, bankers needed to be forced to increase their capital safety buffers to (at least) a fifth of their assets. Second, there needed to be fundamental structural reform to end the "too big/inter-connected to fail" problem. On the first front, regulators have delivered far too little. On the second, political leaders appear to be in the process of surrendering to the vested interests of the banking world. It is hard to avoid the conclusion that, on the eve of the second anniversary of the Lehman Brothers meltdown, the lessons of the banking crisis have gone unlearned.Reuse content