10/27/23, 8:47 PM We Need to Talk About Bank Supervision by Howard Davies - Project Syndicate

We Need to Talk About Bank

Supervision
Sep 22, 2023 |HOWARD DAVIES

LONDON – Bank capital is back in the financial headlines. In late July, US banking regulators, led
by the Federal Reserve, announced plans to finalize the so-called Basel 3 reforms (which banks like
to call Basel 4, owing to their significant impact). The aim, according to a joint agency proposal, is
“to improve the strength and resilience of the banking system” by modifying large capital
requirements to better reflect underlying risks, and by applying more transparent and consistent
requirements.
The announced proposals are tougher than many expected. They will cover more banks – including
some that had benefited from Trump-era concessions – and they will require banks to include
unrealized losses from securities in their capital ratios (among other changes). Overall, US regulators
expect the most complex banks to increase their capital by 16%.
US banking supervisors, led by Fed Vice Chair Michael S. Barr, clearly have been emboldened by
the spate of bank failures that started with the collapse of Silicon Valley Bank this past spring. But
though the political mood has changed after that embarrassing episode, there is still fierce opposition
to the new regulations. Last week, David Solomon, the CEO of Goldman Sachs, warned that the
“new capital rules have gone too far … they will hurt economic growth without materially enhancing
safety and soundness.” Likewise, JPMorgan Chase CEO Jamie Dimon believes they will increase the
cost of credit, potentially making banks uninvestable.
One can find even more blood-curdling forecasts on the Bank Policy Institute’s “Stop Basel
Endgame” website, which warns of “real consequences for families and small businesses across the
country.” Clearly, the proposed rule changes have become a political battle. Nor is this solely an
American issue. The Bank of England has also issued rather tough proposals – though British banks
have eschewed high-flown rhetoric in responding. (When American bankers say, “These proposals
will end human life as we know it,” English bankers merely admit to being a little concerned.)
The debate will play out differently in different places over the next few months. In a recent working
paper,Good Supervision: Lessons from the Field, the International Monetary Fund points out that
capital ratios are currently higher in European banks than in American ones. That may partially
explain why the European Union’s Basel 3 implementation plans do not envisage increases on the
scale proposed in the United States.
But more to the point, the IMF authors conclude that the recent bank failures do not have their roots
in capital weakness. As the Swiss National Bank noted during the collapse of Credit Suisse, “meeting
capital requirements is necessary but not sufficient to ensure market confidence.” The salient
problem was that investors lacked confidence in the bank’s business model, and that depositors were

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10/27/23, 8:47 PM We Need to Talk About Bank Supervision by Howard Davies - Project Syndicate

withdrawing funds at a rapid rate. A lack of liquidity, rather than a capital shortage, was the straw
that broke that camel’s back.
Similarly, US authorities’ reports on this year’s bank failures concluded that risky business strategies,
compounded by weak liquidity and inadequate risk management, lay at the heart of the problem. But
though supervisors had identified many of these problems, they “didn’t insist or require the banks to
respond more prudently while there was time to do so,” the IMF authors explain.
Taking banking supervisors’ recent reviews as their starting point, the IMF authors draw broader
lessons from the post-financial-crisis reforms and their differential implementation across
jurisdictions. Notably, an absolute shortage of capital does not feature prominently among the
weaknesses they identify, though they do argue that some countries use the Basel minimum
requirements as a “one size fits all” rule, thus failing to account for differential risks. There has been
little use of the “Pillar 2” process, whereby regulators can require additional capital if they determine
that risk management is weak.
The IMF authors see far bigger problems in the lack of skilled staff in many places, and in the
pressure regulators feel to make politically expedient, rather than prudent, decisions. For example,
some supervisors pay little attention to corporate governance and business models, partly because
they lack the tools and authority to do so. But supervisors also have failed to help themselves by
under-allocating resources for oversight of small firms, and by following poor internal decision-
making processes.
The IMF’s overall conclusion is that regulation, in the sense of capital or liquidity rules, “is rarely, if
ever, enough.” Far more pertinent is the quality of supervision, and of the supervisors themselves.
It is an important message, and one that central banks and bank regulators around the world should
take to heart as the debate over capital requirements heats up again. Experience shows that marginal
increases in capital ratios, or a touch of inflation in risk-weighted-asset calculations, may have far
less impact than low-cost programs to upgrade supervision. We need a cultural shift to embolden
supervisors to act on their concerns. Earlier interventions, using tools and powers supervisors already
have, could have helped avert some of this year’s unfortunate bank failures.

HOWARD DAVIES
Howard Davies, the first chairman of the United Kingdom’s Financial Services Authority (1997-
2003), is Chairman of NatWest Group. He was Director of the London School of Economics (2003-
11) and served as Deputy Governor of the Bank of England and Director-General of the
Confederation of British Industry.

https://prosyn.org/IRnMRog

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