It might be just coincidence that the Securities and Exchange Commission filed civil fraud charges against Goldman Sachs (GS, news, msgs) in the midst of a contentious debate in Washington over legislation to reform Wall Street.
But it's sure no coincidence that the SEC announced its charges on the same day that comments closed on what's called Basel III.
You're probably up to your eyeballs in speculation about what the charges against Goldman will mean for the Wall Street bank that everyone fears to hate. And you're probably desperately trying to tune out the empty rhetoric that passes for debate over the financial-reform bill in the Senate these days. (Let's just say that when Sen. Chris Dodd, D-Conn., said his Republican colleagues were acting like teenagers, I sprang to my feet at home to launch an impassioned defense of teenagers from such slander.)
And you've quite possibly never even heard of Basel III. But I think the other two much more public stories are simply sideshows to the action in the main ring that is Basel III.
OK, so what's Basel III, and why is it so important?
This set of new regulations for the international banking industry will determine the profitability of banks for the next decade.
Simple as that. And that's something that neither the SEC charges against Goldman nor the financial-reform legislation in Congress can claim.
The price of safety
The Basel III rules, so named because they follow on sets of international banking rules called Basel I and Basel II, drawn up in the Swiss city of Basel, will set much tougher guidelines for Tier 1 bank capital than the earlier sets of rules. That was inevitable in any set of new rules in the aftermath of the global financial crisis.No one is sure how tough these rules will be. The comment period on the draft rules closed only April 16. But just about every national banking industry in the world is worried that the rules will, if not put it out of business, crush profits and put it at a deep disadvantage to banks that aren't required to, or don't strictly adhere to, the new rules.
The worry isn't really over how high the Basel Committee on Banking Supervision will set capital requirements. Banks are pretty much resigned to being forced to raise more capital and to keep higher levels of reserves. It's hard to argue that excessive leverage (and inadequate reserves) didn't play a major role in turning a global financial problem into a very close encounter with global financial meltdown.
The Basel committee's members are representatives of central banks from many of the world's largest economies. The committee has no real regulatory power but sets standards and best practices in the expectation that member countries will take steps to comply.
No, what keeps bankers from Tokyo to New York up at night is worry over how Basel III will define Tier 1 capital. The Basel II rules said banks had to hold at least 4% of their risk-adjusted assets (for a bank, an asset is a loan) in Tier 1 capital, supposedly the safest of all capital, and limited Tier 1 capital to equity and equitylike holdings. One big loophole in Basel II exposed by the global financial crisis was in the nature of these equitylike holdings. Some weren't as safe and liquid as they needed to be. Some equitylike holdings turned out to be, in essence, debt. The effect was to lower Tier 1 capital to as little as 2% of risk-adjusted assets. And that just wasn't enough margin of safety when the global financial crisis hit.
Continued: Impractical proposal
