Howard Davies’s thoughts … Regulating in a pandemic


The years after the 2007-09 global financial crisis were characterised by an orgy of rulemaking by financial regulators around the world to address the weaknesses exposed by the upheavals. Importantly, a renamed and reinforced Financial Stability Board (FSB), reporting to a series of G20 summits, oversaw the process of re-regulation.

Despite the economic impact of the measures and the complexity of making rules to suit the needs of different financial systems, a remarkable degree of consistency was achieved. While the United States had never fully implemented the Basel 2 framework, Basel 3 – featuring, for example, higher reserve requirements – found its way, in more or less recognizable form, into the rulebooks of all the different US banking regulators.

This time is different. Many regulatory changes have been introduced around the world in the last two months, understandably in haste, as national policymakers responded to the COVID-19 crisis with measures to keep credit flowing to affected economic sectors.

Sadly, signs of international cooperation are few. There have been no emergency summits. Regulators have not converged on Switzerland for all-night rösti-fueled sessions to hammer out amendments to Basel Committee rules and guidance. Perhaps supervisors have been Zooming into each others’ spare bedrooms. We do not know. But the announced measures have certainly been piecemeal.

Are the changes made so far broadly consistent from country to country, or is the international consensus forged by the FSB starting to unravel?

For the most part, what we have seen is not another orgy of rulemaking, but rather a bonfire of controls. The Institute of International Finance has faithfully logged 312 initiatives, and is still counting. Most drop into one of three buckets: amendments to capital requirements, guidance on loan loss provisioning, and controls on dividends and other capital distributions like share buybacks.

The changes to capital requirements have mainly affected the buffers imposed on banks since the last crisis under the general heading of macroprudential regulation. Many bankers had come to think that macroprudential supplements would only work in one direction: buffers imposed in credit upturns would be retained in the downturn. Faced with a sharp decline, economic regulators have shown welcome flexibility.

Countercyclical buffers have been removed and banks have been told it is acceptable to dip below their previous minimum capital requirement as loan losses mount. Ten of the OECD’s 37 countries have so far removed the countercyclical buffer. A number of others have adjusted national capital or liquidity buffers. Comparisons are complex, but the changes look broadly similar in effect.

These changes are typically described as temporary. So, banks that may avail themselves of the current flexibility are keen to know when the buffers might be re-imposed and how long they would then be given to meet them.

The European Central Bank has said that eurozone banks would be given “ample” time to rebuild capital. The Bank of England has said the time would be “sufficient.” Academic linguists might debate which word implies a longer period. Unfortunately, lawyers will get involved if regulators do not say more clearly what they mean.

Nonetheless, all this activity does look broadly compatible (at least before the tough timing decisions come to be made). So far, no national regulator has taken an axe to the trunk of the Basel requirements.

There is one potential concern, however. Nicolas Véron of the Peterson Institute for International Economics has argued that the Federal Reserve’s changes to the supplementary leverage ratio amount to a serious breach of Basel 3. The Fed has exempted banks’ holdings of Treasury bills from the calculation of their assets, which are explicitly part of the Basel definition. Véron warns that while the change in itself may not be of great consequence, “if the non-compliance trend is confirmed, the most damaging consequences may be to the United States itself.”

The changes in the second bucket, provisions for loan losses, are harder to assess, partly because the US has not adopted International Accounting Standards, and International Financial Reporting Standard 9 is new and untested. Banks need some guidance on how to interpret it, especially in relation to government-guaranteed loans and loans subject to requested interest holidays. There will be a need to ensure that different national interpretations of IFRS 9 can be justified. It is too early to be confident of that.

The third area, capital distributions, is the one where international divergence is more evident. Regulators in Europe have taken the rigorous view that dividends and buybacks should be suspended. The Fed and the Reserve Bank of Australia have left it to banks to decide whether it is safe to pay a dividend.

Some explanations for this difference seem straightforward. For example, in the last year, 73% of US banks’ distributions have been in the form of share buybacks, and only 27% as dividends, while in Europe 96% of distributions have been paid as dividends. US banks voluntarily undertook to suspend buybacks, which the Fed took into account when taking a more relaxed view on dividends.

Nonetheless, decisions on each side of the Atlantic have attracted strong criticism. Senator Sherrod Brown of the Senate Banking Committee told the Fed that “you have been too eager to provide what you call ‘regulatory relief’ – and what the rest of us call favors for Wall Street.” Similarly, the Banking Policy Institute in Washington has maintained that there is “a good chance that the actions of UK and EU regulators have done significant long-term damage to their banks.”

Who is right? It is too soon to say. But the Basel Committee will have a lot to discuss when it is next allowed to assemble. The priority should be to assess the changes that members have made during the crisis and to address those that have skewed the playing field. That will be a delicate exercise, but it is essential if the global financial architecture painfully rebuilt after the last crisis is to be sustained.

Howard Davies is Chairman of the Royal Bank of Scotland.

Copyright: Project Syndicate, 2020.

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