In 2011, we issued a heartfelt plea to the Basel Committee: do something about what I call “complexity risk.” Earlier this month, it did, issuing a paper stipulating simplicity and comparability as possible global bank-regulatory priorities. Yes, this is only a possibility — what at least to me seems like an incontrovertible policy objective apparently requires a 24-page consultation that parses the pros and cons of simplicity and comparability with such exactitude (not to mention in so much ill-translated prose) as to make even these worthy ideals seem strangely troubling. Joining many of my similarly-optimistic friends at Treasury and in the U.S. banking agencies, I have hoped that Basel would bring order from the chaotic, conflicting body of national rules. But, if Basel can’t even define simplicity in a coherent way, there’s no hope for anything harder anyone could reasonably implement in a sensible, measurable, cross-border way.
Why so gloomy? Take a look at page three of the consultation, where Basel takes 31 sentences in four daunting paragraphs to define “simplicity.” In the second sentence of this opus, Basel already goes off track: “Simplicity… has two dimensions: the simplicity of the capital standard itself and the simplicity of the capital calculation process.” This is to be found in paragraph 9. In paragraph 11, one finds that: A capital calculation process is simple if it requires:
“Simple inputs: “a simple standard does not require a large number of inputs and avoids reliance on inputs not captured within the normal accounting or risk management systems of banks (i.e., the inputs are subject to internal or external validation so the data called for is more readily accessible, better understood, and more reliable). Simple calculations: a simple standard can be calculated without the need for the use of highly advanced mathematical and statistical concepts, avoids iterative calculations, and can be easily verified by external parties such as supervisors or auditors.” “Comparability” – Basel’s other icon – is also not easy to understand once Basel weighs in. This definition goes on for two paragraphs across two pages. Regulatory frameworks deliver “perfect comparability” if they meet the following criteria:
“Comparability between banks: two banks with portfolios having identical risk profiles apply the framework’s rules and arrive at the same amount of risk-weighted assets and two banks with different risk profiles should produce risk numbers that are different proportionally to the differences in risk.
Comparability over time: a bank’s risk-weighted assets do not change over time if the underlying risks remain unchanged, and change proportionally when risks do change.
Comparable information: any differences in risk-weighted assets across banks, jurisdictions and over time can be understood and explained.”
Sorry about that – and don’t blame me either for the punctuation (verbatim as is everything else you just waded through).
After all this dithering, Basel comes to a conclusion – it likes risk-based capital even though it then says that risk-based capital should be made more simple and comparable, perhaps by using a leverage standard that should be illuminated (with or without continuing risk-based capital) through at least seven new metrics and after consideration of too-many-to-count additional ways to measure leverage. One “simple” idea – use a new ratio – not defined – to come up with something called “income volatility” and then base leverage on it. And, if this isn’t enough, Basel broaches a new issue that’s anything but simple or comparable: let capital rules aim at other policy objectives, not just promoting bank solvency.
Why is Basel so flummoxed by simplicity and comparability? At the heart of the problem, I think, is a frustration touched on in this paper: national discretion. Basel intriguingly recommends an end to this as a policy option for consideration. Presumably, it contemplates becoming an uber-regulator across the globe, issuing edicts – maybe even simple and comparable ones – to which all must adhere or else. Good luck with that.