Crumbling consensus on international banking regulation risks financial stability

Is the banking sector prepared to withstand another financial crisis? Sixteen years on from the Lehman Brothers collapse, Finance Watch’s latest report examines Basel III’s impact on global banking stability and presents recommendations to advance international banking regulation. Once an example of international regulatory consensus, the momentum behind Basel III has stalled. 

The EU’s recent decision to dilute and delay the full implementation of global bank capital rules signals a troubling shift. In reality, the EU is at risk of non-compliance with Basel standards, as highlighted in a 2022 letter from top EU banking supervisors. Meanwhile, the US Federal Reserve has faced fierce resistance from banks over its proposed implementation of Basel, recently halving the proposed increase in capital requirements. Similarly, the UK has diluted its proposed capital regime and delayed its introduction until 2026. 

Despite 2023’s record bank profits, recent failures like Crédit Suisse and Silicon Valley Bank reveal persistent weaknesses in the financial system. Authorities are still forced to commit billions of already scarce public money to prop up failing institutions. This report, framed around eight critical questions, highlights the shortcomings in the Basel III framework, and delivers recommendations to support global financial stability.

Finance Watch calls for a renewed political commitment to improve the Basel III framework. Key recommendations include:

• Harmonising Global Implementation: Simplify the complex regulatory landscape, reduce the scope for national deviations and enforce uniform rules to ensure a level playing field for internationally active banks worldwide.
• Enhancing Bank Supervision: Strengthen bank supervision by developing global frameworks and standards for real-time prudential reporting and supervisory data access. Scale back the involvement of bank supervisors in the pre-approval of internal risk models and concentrate scarce expert resources on core supervisory tasks
• Incorporating Climate Risk: Integrate climate risk into banking regulations, addressing the financial dangers of stranded fossil fuel assets to prevent massive future losses.

The report suggests that the complexity of the Basel III framework may undermine its effectiveness and that internal risk models used by banks project a false sense of predictability and continue to distort competition in favour of the largest institutions. The report advocates for a more proactive role for the Basel Committee in harnessing state-of-the-art digital technology for supervisory purposes and addressing the systemic risks posed by climate change.

Moreover, it calls for a harmonised and standardised approach to define “internationally active” banks, streamline the framework to ensure consistency and comparability, and phase out internal model-based approaches in favour of standardised risk-sensitive methods.

Finance Watch calls upon European policymakers, both at the Union and member-state level, to reinforce their commitment to the Basel process and re-engage proactively with its partners, especially in the US, to prevent a regulatory “race to the bottom”. An open global financial system requires a consistent global set of prudential standards.