As European countries prepare to introduce Basel III, concerns are mounting that its implementation will highlight a chasm between different countries in terms of bank capital levels. Is the banking sector about to see a new era of regulatory arbitrage?
National implementation for Basel III is required by January 1, 2013. The body tasked with refereeing the process in Europe is the newly minted European Banking Authority, created last year to replace the relatively ineffectual Committee of European Banking Supervisors. The EBA has been assigned a broad set of competences, including preventing regulatory arbitrage, strengthening international supervisory co-ordination and promoting supervisory convergence.
In a first test of its mettle, the EBA was criticised in recent weeks by regional German banks for its proposed stress tests, which Norddeutsche Landesbank and Landesbank Hessen-Thüringen claimed were unfair.
Switzerland, meanwhile, has no time at all for the convergence principle. Using its discretionary powers under Pillar II of the Basel proposals, Finma in April set out five levels of capital buffer based on banks' size and complexity, ranging from 10.5% to 14.4% of risk-weighted assets. That compares with 8% recommended under the Basel framework.
Switzerland's two biggest banks, UBS and Credit Suisse, have been required since 2008 to bolster their capital to levels of 50%-100% above the current Basel II standard. The Swiss parliament is currently debating whether to cement the standard for systemically important financial institutions at 19%; well above the most ambitious standards envisaged by Basel III.
Officials at Finma claim to be unperturbed by concerns over the impact of tough rules on Swiss competitiveness, but at least one opposition party in the Swiss parliament has come out against the proposals. A spokesperson for the State Secretariat for International Financial Matters, a Swiss government financial body, says: "There is a debate first over whether Switzerland should go so quickly, rather than wait and see what is happening internationally, and also whether it should go beyond the Basel requirements. However, while there is opposition on one side there are also those that say we should go even further, and that the proposals are not tough enough."
Swiss politicians are likely to be less than impressed with the reaction of UBS chief executive Oswald Grübel, who was quoted as saying the new standards could force UBS to move units abroad. He added that investment banking activity across Europe could shift to the US and Asia if stricter capital requirements are enforced in the UK and Switzerland.
Even within the Basel Committee, there was recognition in April that any move by national regulators to "punish" banks perceived to have exacerbated the financial crisis could encourage jurisdiction shopping among the most powerful firms.
"If we have higher capital requirements, we are going to have higher incentives for regulatory arbitrage," said José María Roldán, chairman of the standards implementation group of the Basel Committee. "Within banks, across banks, across countries, if you have an uneven application of Basel III you will see banking activity going to the country that has a softer approach." The risk of regulatory arbitrage was an "unavoidable consequence" of the new framework, Roldan said.
Under the Basel III proposals, the minimum total capital plus conservation buffer should reach 10.5% of risk-weighted assets by 2019, some 2.5% higher than the current minimum requirement. If another element, the countercyclical capital buffer, is fully added, the minimum total capital requirement will be 13% of risk-weighted assets.
Amid sabre rattling from the likes of HSBC and Barclays, the UK has become a test case for the regulatory arbitrage debate, after the Independent Commission on Banking published its interim recommendations for the UK banking sector in April.
One area in which the ICB stepped beyond the recommendations of the Basel Committee, or any European country, was on retail depositors, who it suggested should have legal preference over other creditors, in line with the US and Australia.
The most controversial ICB proposal, however, focused on the breaking up of the universal banking model, and the ring-fencing of the domestic retail banking operations of the major UK banks, suggesting that the business be conducted in a separate legal entity, with its own capital requirements. No other country in Europe has considered changing its banking model in such a fundamental way, and with the ICB's final recommendations due in the autumn, the idea has prompted a heated debate.