After you read this, you will care about Basel III
By Mitchell Hartman
The Federal Reserve today approved final rules under the Basel III international banking agreement, increasing capital requirements for all U.S. banks. The regulations come into effect over several years. The goal of the regulations is to reduce systemic risk to the financial system — and especially to the largest banks, sometimes called ‘systemically important’ or ‘too big to fail’ — by bolstering the amount of shareholder equity banks must maintain. Banks will need to maintain a total capital ratio of 8 percent of risk-weighted assets. “Sooner or later something will go wrong,” says Karen Shaw Petrou, managing partner Federal Financial Analytics. “And they’ll go less wrong if shareholders have more at risk. Shareholders will be less likely to look the other way” if bank executives and employees take big risks that go bad. “If banks fail, the deeper cushion of shareholder equity up front reduces the cost of the failure to the FDIC or to other regulators.” Petrou says Basel III’s capital requirements should mitigate, at least somewhat, the kinds of risks faced by the banking system, and ultimately the entire economy, during the 2007-2008 financial crisis. “Banks had thin capital cushions,” says Petrou. “And when markets went upside down, they blew up. They couldn’t even sustain overnight stress, because they had no resources to hang on.”