Karen Petrou: Why the Basel Capital Construct is Broken and How to Fix It
Last week, the head of Britain’s key financial-regulatory agency, Sam Woods, stunned his Basel colleagues by suggesting that the entire edifice of Basel I, II, II.5, III, and what is rightly called IV should be tossed out in favor of something far more elegant and considerably less procyclical than the thousands of pages of Basel minutiae. Mr. Woods calls the alternative the “Basel Bufferati” in honor of the concept-car approach to auto innovation and it’s hard not to like something with such a cute name that might also achieve these essential goals. But, Mr. Woods’s Bufferati drives on the power of regulatory discretion over key considerations such as when there’s systemic risk and how susceptible to it each bank is likely to be. Been there, done that, it didn’t work.
The key features of the Bufferati are a minimums standard that’s a single number comprised only of common equity Tier 1 capital set by each supervisor’s judgement and a buffer for good measure set by “macroeconomic cost-benefit analyses.” The buffer could be released under stress and the minimum doesn’t necessarily bind even if there isn’t stress, making it unclear what either of these thresholds is other than ratios that might be useful cushions against undue risk-taking if supervisors guess right about both the bank and the financial system.
Could they? The idea of leaving minimum ratios to supervisory judgment actually harks back to the world before Basel I, when each nation’s supervisors looked at each of its banks and set …