Over at TVHE, Matt writes about the BIS arguing that structural adjustments and balance sheet restructuring should be imposed on the world without any democratic input. He makes it clear that there has to be some democratic input into these processes. I argue that the BIS has already won a cold war against risky lending with Basel III.
The Bank of International Settlements is a technocratic institution based in Basel, Switzerland. Alongside providing a lot of good stuff in the form of supervising global payments systems and coming up with some very good global settlement policy, it has also produced one of the most complicated pieces of technocrat policy since Bretton-Woods.
That would be Basel III – a series of capital and liquidity requirements for all banks around the world. Check your local bank’s Key Disclosure Statement – you’ll find a lot of footnotes stating how they’re transitioning towards Basel III compliance and some banks are even raising additional capital so that their Tier 1 capital ratio is higher than it needs to be “just in case”.
These capital and liquidity requirements are obviously a good idea in the aftermath of the global financial crisis. Investment banks like Lehman Brothers and Bear Stearns over-extended themselves on mortgage-backed securities and when they marked their positions to market, they essentially were worthless.
The US Treasury, using AIG Financial Products as a conduit, paid out the credit default swaps on all of these sub-prime CDOs at 100 cents on the dollar. This transferred hundreds of billions of dollars from US taxpayers to Wall Street banks.
In essence, Basel III is a technocratic series of rules and committee based supervision (seriously) that aims to avoid a repeat of 2008. The theory goes that if banks have to hold more capital and make fewer risky loans, then the financial system will be more stable and there’ll be no need for big bank bailouts.
The BIS has essentially changed the way every single bank abiding by or transitioning to Basel III does business. Why? Because different types of loans require different levels of reserves held against them in case of default. Different types of equity offer different levels of capital the bank can use in calculating its compliance with Basel III.
This means that, without any democratic input, the BIS and everyone participating in the Basel III process has already imposed massive structural adjustments on how capital is allocated in literally every single country! The technocrats have already changed how every single bank in the world prepares its financial statements and manages its balance sheet! If that isn’t a technocratic imposition without reference to democratic processes I don’t know what is.
Why are banks happy to lend on houses but not to small businesses? Because they need higher loss reserves for business lending. Ergo, you can borrow a $1 million for a house but borrowing $1 million for a development to increase housing supply is almost impossible unless you already have $1 million in net assets as security, rendering the whole point of participating in the bank lending market moot and the likelihood of any economic recovery relying on credit negligible.
What does this have to do with Basel III? Well, with quantitative easing injecting enormous amounts of liquidity into the financial system at the same time that higher capital requirements and liquidity constraints have been imposed on banks and financial institutions, it simply makes more sense to keep stuff on your balance sheet in assets that enable you to count them as Tier 1 capital under Basel III rules. That is why financial institutions have returned to profitability so quickly.
Thus, in the pursuit of financial stability, the Basel III process has also made it less likely that loans will be granted to the risky activities that will bring the Western economies back into growth mode. There is a trade-off between financial stability and credit being allocated towards risky activities like business startups and property development.
Remember, when private sector demand for credit is down, and banks need to raise enormous amounts of capital to meet Basel III requirements, how focused will they be on performing their role as a capital allocation utility i.e. the reason they’re given banking licenses? How focused can you be on business development in property lending when you made big mistakes in the last boom and now have a whole plethora of new rules around who you can lend money to?
It’s almost as if the technocrats did not believe that there were any tradeoffs in pursuing policy that, funnily enough, I think the average person in the street would wholeheartedly approve of. Regulation has consequences. We should be very concerned that the Reserve Bank wants to increase its level of “macro-prudential supervision” through loan-to-value restrictions.