Former LSE Director Howard Davies shares his ingenious insights into the new Basel 4 accord.

As former chairman of the British Financial Services Authority and former director of the London School of Economics, Howard Davies shares his ingenious insights into the new Basel 4 accord. This new accord balances the U.S. and French bids for minimum bank capital output floors to arrive at the key midpoint of 72.5% equity capital output under the old Basel standard approach. In fact, this harmonization helps reduce substantial heterogeneity in internal capital requirements under the prior Basel 3 regime. Although the use and introduction of internal risk models can facilitate risk-sensitive and meaningful core capital calibrations, wide capital output dispersion may be suboptimal. This wide dispersion suggests that the core capital results may differ dramatically when the bank applies different internal risk models to calibrate to the same loan portfolios. Also, some proponents point out that most recent improvements in core capital ratios result from lower private credit growth (rather than higher net equity issuance). Should banks raise equity to strengthen their core capital ratios toward the healthy range of 10%-15% or even 20%, these banks may experience high costs of capital with less available loan credit. These ripple effects can adversely affect real macro variates such as real GDP economic growth, employment, and capital equipment usage. It is thus important for global regulators to standardize minimum core equity capital requirements to assuage these concerns.

In addition to the Basel regime switch, the Federal Reserve vice chairman Randal Quarles proposes simplifying the Volcker rule that prevents banks from using their own money to place hefty market bets on stocks, bonds, indices, funds, currencies, commodities, and derivatives. In recent years, many eminent economists point out that the Volcker rule cannot be one of the culprits of the global financial crisis from 2008 to 2009. The Volcker rule may be too restrictive for most global systemically-important banks.

As part-and-parcel of this new influx of new bank rules, it is important for banks to carefully craft their living wills for better open bank resolution during a key financial crisis. Open bank resolution may involve outright liquidation, bank recapitalization, or bridge-bank sale. Overall, these new regulations can be conducive to promoting sound and efficient bank capital arrangements in most home-host jurisdictions.