The Basel Committee’s Ripple Effect Ripostes

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A Center for Global Development task force of academics and multilateral lender and central bank officials channeled emerging market criticism of the Basel III formula into a lengthy report on recommended methodology changes and further research so that a common regime can “work for developing countries.” It notes a “sharp fall” in cross-border global bank lines the past decade, only partially bridged by bond issuance and new South-South flows, which may be due to advanced economy incorporation of the standards. The panel calls on the IMF-housed Financial Stability Board to study the topic, and also examine the asset class implications for infrastructure projects in particular assigned high risk weighting. Home and host country supervisors often clash in setting norms on a consolidated group basis, and regional networks in Latin America, Asia, Europe and the Middle East/Africa may choose tailored rules and monitoring for their close ties. “Proportionality” is desired to reflect the financial system and data realities on the ground, and tradeoff between oversight and growth. The capital and liquidity ratio minimums diverge from the “gold plated” industrial world practice of ratcheting up and adding buffers following credit/GDP measures that do not necessarily apply. Small business and trade finance and capital market building can be greater priorities if the Basel Committee opens to smaller emerging economy members beyond the G20, the review suggests. The basic core principles could then be modified and more universally aligned in the near term, rather than the current version phasing in over years and relying on complex internal and external guidelines suitable only to a minority. Emerging market institutions in contrast are subject to economic volatility, securities depth, data transparency, and capacity-governance limits at odds with the Basel III and potential successor frameworks.

Anti-money laundering/ terror funding and tax information guidelines increase pressure in these geographies, with correspondent bank relationships “significantly decreased.” With quantitative easing’s negligible and negative interest rates since the global financial crisis, emerging market corporate and sovereign debt has mushroomed into a multi-trillion dollar market, but long-term allocation matching loan arrangements is unclear. China through its policy banks and Belt and road Initiative has the biggest South-South nexus but they do not report within the BIS classification, and spillovers could spike with restructuring episodes as currently in Venezuela. The IMF calculates separately that 60% of infrastructure funding is advanced economy-sourced even with Chinese inroads, with current Basle III categories strict on project phase and overall borrower exposure. It could be hedged if tools were available, but formal derivatives markets are thin or nonexistent across the developing world. Foreign bank assets are half the total in a cross-section of the universe from Sub-Sahara Africa to Mexico and Poland, with local and hard currency sovereign debt treatment in conflict. “Shadow” banking’s size and linkages to the conventional system argue for inclusion in China, India and other major emerging markets. Regulators there may need to create a “systemic liquidity tool” to hold in reserve given the chance for government bond shocks and the absence of supplemental safe assets. Securitization can be encouraged to move items off balance sheets and promote investment business, and with wider use Basel authorities may loosen the criteria left from the crisis mortgage fiascos in the US and Europe. New asset-backed forms can benefit the real economy so that they become a public good through private operations, the CGD comments.