It ends with us. Years before those words were used for the title of a best-selling romance novel, they could easily have been the rallying cry of global regulators, as they announced the “finalisation” of the Basel banking rules in 2017, to overhaul lax banking standards.
But, now, that promise of a regulatory endgame to toughen capital, liquidity and resolution rules is coming back to haunt policymakers, who are considering further regulatory changes in the wake of the collapse of Silicon Valley Bank, Signature Bank, Credit Suisse and, most recently, First Republic.
“If you take the view that these are standards that you can set once and for all, then they’re doomed to fail,” argues David Aikman, professor of finance and director of the Qatar Centre for Global Banking and Finance at King’s College London.
The Basel Committee on Banking Supervision, which sets global standards, has said it is reviewing recent events, to see if there are lessons to be learned, and rules to be enhanced.
“It is important to keep an open mind at this stage about whether any potential revisions to the global regulatory and supervisory framework are needed,” Pablo Hernández de Cos, Spain’s central bank governor and chair of the Basel Committee, told the Eurofi conference on April 28.
Although the crises that engulfed the three US banks and Credit Suisse were all unique to an extent, there are commonalities between them. All four suffered from a bank run when depositors rushed to withdraw their money en masse, destabilising the lenders, who then had to rapidly sell assets so they could meet their customers’ demands.
The UK and the US are both looking at changes to their deposit guarantee schemes, which they hope would dissuade customers from bolting when uncertainty and fear set in. Global regulators are also looking at modifications to the liquidity coverage ratio, which requires banks to be prepared for runs of a certain speed. The collapse of SVB in particular — which lost $42bn, or a quarter of its deposit book, in a single day — proved that banks should be prepared for much faster runs, and revised rules are expected to reflect that.
“Liquidity stress testing/rules present an area where all countries need to do more work,” says Sheila Bair, former chair of the US Federal Deposit Insurance Corporation.
As well as changing assumptions around the speed of bank runs, Bair says regulators might want to revisit their treatment of government-backed debt, which is treated as highly liquid regardless of its maturity, and of uninsured deposits, which are “probably treated as more stable than they really are”.
The risks from rising interest rates are another common thread running through the US bank collapses. When depositors rushed to withdraw funds, lenders had to sell the bonds they had bought with depositors’ money.
Those bonds were top-quality government debt, but their market price had fallen because rising interest rates make old bonds paying lower rates less valuable. Under US accounting rules, banks were allowed to ignore that fall in value, even if the bonds were part of their “available for sale” portfolio, rather than the ones they planned to hold until they matured.
“When interest rates rise, this treatment masks market losses on their AFS (available for sale) investments, making their capital position look stronger than it really is,” explains Bair, who argued for the US to follow the global approach and force banks to recognise losses on their AFS bonds in real time.
But there are also broader issues with the way interest rate risk is managed. Regulators try to capture the risks of interest rate changes through a capital add-on called “interest rate risk in the banking book” (IRRBB). Capital charges for factors such as lending risk are captured in Pillar 1 — which covers the main capital requirements and has hard and fast global standards — whereas interest rate risk is in Pillar 2, which addresses capital requirements where national supervisors have vast discretion.
“There is a framework for Pillar 2 that some jurisdictions implement [for IRRBB], including the UK,” says Aikman. But he adds: “There are questions about the stringency and adequacy of that framework that regulators would want to take another look at [including] whether it is transferred to Pillar 1 and implemented across the board.”
In addition, regulators must decide to whom the Basel rules apply. “I don’t think there are significant changes needed to the global Basel framework; the tools are there, we just need jurisdictions to implement them faithfully,” suggests Jeremy Kress, assistant professor of business law at the University of Michigan Ross School of Business.
Banks in turmoil
The global banking system has been rocked by the collapse of Silicon Valley Bank and Signature Bank and the last minute rescue of Credit Suisse by UBS. Check out the latest analysis and comment here
The Basel Committee agreed to apply the rules to their “internationally active” banks — but that term has never been defined. So, in Europe, regulators decided to apply the rules to almost every lender, while US regulators took a phased approach: applying the most stringent of the Basel rules to banks with a balance sheet of more than $700bn; a lighter package to those with more than $250bn; and even fewer to those with smaller businesses.
As a bank with less than $250bn in assets, SVB therefore did not have to comply with Basel liquidity rules and some other elements of the Basel package, even though it had significant operations overseas. The bank also benefited from Trump-era deregulation that gave lenders a three-year grace period on stress tests.
The US authorities were reviewing the appropriateness of those lighter touch rules before SVB triggered a spate of midsized bank failures. And, if US regulators do not get there on their own, the Basel Committee could try to force their hand as it considers whether there is a case stipulating that the rules be applied across a larger group of banks.
Whatever change does come, it is unlikely to be swift, though. The 2017 Basel package is delayed in most jurisdictions until 2025. If any further enhancement of the global rule book follows a similar timeline, we might not see the results until 2030, by which time the memory of the recent bank failures may have faded — and the “it ends with us” promise even more so.
