On Sept. 12, the Basel Committee on Banking Supervision, a coalition of global regulators from 27 nations, proposed a historic revision of the world’s collective banking regulations. These new requirements, coming a full two years after the collapse of Lehman Brothers, have been crafted to hinder the furtive activities that perpetuated the financial crisis of 2008 and dramatically decreased the solvency, stability, and reliability of the international global system. The new rules represent a tremendous compromise of regulatory perspectives throughout the international financial system, as the last crisis soured international relations.
The framework of the regulations are largely credit-sensitive: the reserve requirement, designed as a leverage mechanism by which banks hold a minimum percentage of demand deposits in the Federal Reserve Bank, will be expanded by a factor of three. As an asset to each bank, the reserve requirement perpetuates the stability of the entire banking system and, when low, allows for the liquidity across the financial system.
The new regulations allow for banks to have large amounts of capital that are much more protected against the inconsistencies of the stock market.
The proposed increase in the reserve requirement has a significant trade-off: while it will decrease the volatility of the financial system, it will also decrease the collective amount of funds within each bank, translating to a lesser amount of loans and credit distributed. Nevertheless, the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency have issued a press release, exclaiming that the accord “represents a significant step forward in reducing the incidence and severity of future financial crises.” Notably, the Obama administration has pursued this proposal with fervency, intending to use this landmark safety regulation as proof of their reliability in time for elections.
Individually, the regulations will also decrease the profit margins for banks. A higher reserve requirement will discourage speculators from investing in risky, but lucrative, business deals. The regulations will also lead to a gradual international credit crunch that will make people less inclined to invest their capital in the banking system.
The regulations also mandate for banks to increase the amount of common equity they hold from 2 to 7 percent. This allows for a 2.5 percent buffer banks could extract during times of crisis – but this, too, has its provisions: it limits the amount executives and shareholders can be paid.
Joe Peek, professor of international banking and financial economics at the University of Kentucky, summed up the regulations well: “It will make banks less profitable, but it will [also] make the system safer, because there will be more of a cushion from insolvency.”
Regulatory interests have been pressured to phase out the changes over a period of years; the regulations in their entirety will be completed by Jan. 1, 2019. In the meantime, due to tremendous potential for these regulations to be mandated, banks are in the process of voluntarily depositing more money in the Federal Reserve, hoping to transition well and cause less of a domestic credit crunch.
Sagar Shah is a chemistry and economics freshman and may be reached at [email protected].
