Last week was of course one in which the financial-sector took a drubbing.  However, as we’ll discuss below, politics is proving a big distraction from the profound policy changes proposed by the Basel Committee. 

Anticipating big earnings and monster bonuses, the Obama Administration tried to get ahead of growing calls to punish big and seemingly bad bankers.  A day before earnings season kicked off in earnest, the President proposed a tax on the very biggest financial institutions (see Client Report CRISISFEE).  Dubbed a fee in hopes of bypassing legislative obstacles on the Hill, the charge is a 0.15 percent levy on non-core liabilities, adjusted for Tier 1 capital. Ouch.The idea followed the first hearing before the Financial Crisis Inquiry Commission (FCIC, see FSM Report REFORM11).  At its first day of hearings (see Client Report REFORM34), the FCIC called in four big bankers to launch their inquiry with cameras rolling.  Although the policy implications of the FCIC examination remain uncertain, the politics did little to take the heat off a beleaguered industry increasingly awash in public opprobrium. 

However, as noted, we think the politics in Washington is distracting attention from yet another challenge:  the fundamental rewrite of regulatory capital pending in the Basel Committee.  Last week, we provided clients with in-depth assessments of the capital proposal, following our initial review of both it and the accompanying one on liquidity risk (see Client Report RISKMANAGEMENT4).  Highlights in the reports on the Basel II consultative paper include: 

·         an overall review of the proposal and its complex timing, which may be found in FSM Report CAPITAL157.  As detailed in that report, a critical question is how the Basel Committee will calibrate and implement the specific proposals discussed below.  The sum total of all of them would, FedFin believes, result in a punitive capital charge that could collectively so clean the banking industry’s clock that the “shadow” banking system would rise in unprecedented form despite the Basel Committee’s goal of clamping it down for good;

·         a set of new “quality” capital requirements, analyzed in FSM Report CAPITAL158.  These would, as detailed in the FSM Report, rewrite Tier 1 capital to force so tough a focus on tangible common equity as to end the value of many capital instruments that comprise large percentages of many bank capital bases;

·         expanded capital for an array of new exposures, as analyzed in FSM Report CAPITAL159.  The “quality” capital proposal would hike the capital numerator, but the new requirements for an array of on-and-off balance sheet obligations would do the same for the denominator, further toughening the proposed regime;

·         a new leverage standard that builds on the tough new risk-based requirements with a minimum one for on-and-off balance sheet obligations (including credit default swaps, securities lending and other risk exposures long outside any capital requirements).  This part of the consultative paper is analyzed in FSM Report CAPITAL160 and

·         proposals to address procyclicality, analyzed in FSM Report CAPITAL161.  This is the most tentative part of the consultative paper, although the regulators do propose one change – dynamic provisioning – that accomplishes a long-held banking industry objective of setting loan-loss reserves for expected – not incurred – loss.  However, this is proposed in tandem with other provisions that, like everything else in the consultative paper, toughen up the capital standards.  For example, new “buffers” would be required that bar dividends, bonuses or other capital distributions when a bank is under stress. 

Comment on all of these proposals is due by April 16.  The U.S. is of course well behind the global curve on regulatory capital rewrites, but the agencies plan quickly to implement the global proposals once they take more certain final shape.