Countries Make Headway on Basel III, But More Work Needed

WASHINGTON — The Financial Stability Board on Tuesday outlined progress, and in some cases weaknesses, of pledges made by countries to adopt tougher capital rules in order to strengthen the global financial system.

In a 35-page report to leaders of the Group of 20 nations, who met in Los Cabos, Mexico for two day of talks, the FSB provided a status update on several critical areas where leaders had vowed to make commitments, including lifting capital and liquidity requirements for global banks, reforming compensation practices, putting into place resolution frameworks, and improving monitoring of the shadow banking system.

"Since the onset of the global financial crisis, the G20 has established core elements of a new global financial regulatory framework that will make the financial system more resilient and better able to serve the needs of the real economy," the FSB's report stated.

Ahead of the G-20 meeting, the Basel Committee on Banking Supervision provided a status report to global leaders on how the 27 participating countries were moving ahead with implementing Basel 2, 2.5, and 3.

The three-level review included how countries were working to meet the rules, if they were consistent with three separate Basel accords, and whether they were aligned when it came to risk-weighted assets. Those results were included in the FSB's overall report.

Thus far, 20 of the 27 countries have put forth their own final rules to implement Basel 2.5 to improve capital charges for banks' trading books and complex securities. The rules became effective at the end of last year and six countries have yet to issue final regulations.

The U.S. has lagged behind in implementing Basel 2.5, but earlier this month regulators voted to finalize its market-risk rule, as well as release proposals that would establish a minimum capital requirement, leverage ratio and a countercyclical buffer as part of its effort to implement Basel III.

Seven countries, according to the FSB's report, have been slow to issue draft or final Basel III regulations, which kick in January 2013. The report did not name those countries. Still, the majority of countries said they anticipate issuing final regulations by the deadline.

The Basel Committee created a peer review process to monitor implementation of Basel III to ensure each country was consistently applying the minimum standards in the agreement.

To date, the Basel Committee has started peer reviews for the United States, European Union, and Japan and has warned in its preliminary review that it has found some deficiencies, but it was still early to be conclusive.

"The formulation of national standards is still ongoing," the FSB wrote in the report. "Nevertheless, there is a possibility that national and regional implementation will be weaker than the globally agreed standards in some key areas."

The Basel Committee will provide an updated progress report in time for the G20 Finance Ministers and Central Bank Governors meeting this November, which would include an update on its members' domestic rule-making, the final outcome of the regulatory consistency of U.S., EU, and Japan, and preliminary findings from its deeper analysis of banks' risk measurement approaches and regulatory capital calculations.

The FSB said a review of how Singapore's regulations are matching with the international standards will start later this year and reviews of China and Switzerland will follow next year in 2013.

"This schedule ensures that all countries that are home to G-SIBS will have been reviewed before the middle of 2013," said the FSB's report.

Reviews of Australia, Brazil and Canada will take place in the second half of 2013.

On liquidity standards, global regulators previously agreed to an observation period for both the liquidity coverage ratio, which was timed to be introduced by 2015, and the net stable funding ratio, which would kick-in by 2018.

Regulators have gone back to the drawing board to revise the two liquidity requirements, which would cover short-term and long-term funding needs, to heed concerns.

The Basel Committee has been asked by the Group of Central Bank Governors and Heads of Supervision to finalize and publish recommendations by the end of 2012 to address specific concerns regarding "the pool of high-quality liquid assets as well as some adjustments to the calibration of net cash outflows so as to reflect the actual experience during the crisis."

The Basel Committee still aims to finalize the LCR by the end of 2012 with a view of implementing it in January 2015. The NSFR will still be implemented in January 2018.

The FSB also updated regulators on countries progress in ending the problem of too-big-to-fail by setting up individual resolution frameworks.

"The G20 is determined to make sure that no financial institution is too-big-to-fail and that taxpayers do not bear the costs of resolution of any institution that does fail (and cannot be put into solvency for reasons of system stability," the FSB wrote in its report.

The FSB has already laid out a set of standards that each country should use in developing resolution regimes to safely unwind banks without any exposure to the taxpayers.

Countries like the U.S., the United Kingdom, and EU have already either put in place or proposed legislation to establish effective resolution regimes, according to the FSB. Even with such initial progress, there is more work that still needs to be done with other countries they cautioned global leaders.

"Much further work on resolution plans and on cross-border co-operation is needed to improve resolvability," said the FSB's report. "Progress is being made in national legislative reforms to establish more effective resolution regimes."

Cross-border crisis management groups have been established for 24 of the 29 designated globally systemically important banks, which includes Bank of America, JPMorgan Chase, Wells Fargo and Citigroup, but more work is needed to develop resolution strategies and plans, the FSB noted.

On compensation practices, nearly all countries have applied principles and standards established by the FSB for sound compensation practices in regulation or supervisory guidance.

Since the last G-20 meeting in Cannes, countries which showed significant gaps have made progress. Even so, the FSB warned global leaders that sustained supervisory and regulatory attention would be needed to achieve lasting improvements in financial firms' compensation structures and practices.

Countries have already taken initial steps to improve monitoring the shadow banking system, a growing concern for regulators in the U.S, since the last meeting.

For example, U.S. regulators under the auspices of the Financial Stability Oversight Council have the authority to subject any non-bank financial company to a detailed review if it is considered a systemic threat. The European Central Bank has proposed establishing an EU Central Database on Euro Repos to improve data on the repo market in the Euro area, while Canada has begun work to examine its domestic banks which interact with shadow banking entities in the national marketplace.

Last October, regulators said they would conduct a yearly monitoring exercise to assess global trends and risks in the shadow banking system. The first report last year covered 11 countries and plans are in the works to extend the cover to all remaining countries this year.

"The annual monitoring exercise is expected to facilitate the national authorities' assessment of shadow banking risks based on the FSB recommendations, and the sharing of experiences among authorities in order to highlight trends in shadow banking that are of relevance to the stability of the global financial system," the report said.