The Basel III

Endgame
The Unintentional
Consequences of the Basel
Endgame
Financial history is littered with the
unintended consequences of regulatory
changes. Capital controls in the 1960s
drove international borrowers to move
from the US to create the eurobond
market. The deregulation of savings
and loan banks in 1980 contributed to
the industry crisis later that decade.
And on and on.

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So what to make of the Fed’s
1,000-plus-page proposal for new
bank regulation. Dubbed the “Basel
Endgame, it calls for a 20 to 25 per
cent increase in capital requirements
for the largest banks, according to
JPMorgan’s Jamie Dimon
Aside from worries that such a sharp
increase in capital could slow
economic growth by reducing
lending, three possible unintended
consequences stand out.

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First, a new threat to US energy
transition lurks in bank regulation. The
proposals contain a rule which could
inadvertently throw cold water on
billions of dollars of solar and wind
investments.

3
The proposed rule would increase by
fourfold the capital required for a key
source of funding solar or wind farms,
rendering them prohibitively
expensive for many banks. Already,
some banks are pausing, according to
policy advisory group Capstone.

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The private credit market could pick
up some, or perhaps all, of the slack
over time. But the unravelling of this
source of finance could hinder the
financing of many projects the IRA
envisioned.

5
Second, the Fed may need to step in
as the lender of last resort more
frequently.
The new rules propose that for
capital for trading, the risk weighting
increase by a whopping 70 per cent.
There is already considerable
concern about the withdrawal of
banks in market marking — and this
is likely to make this issue worse.

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Third, the proposal could incentivise
more corporate lending to shift to
private markets.

It is likely to penalise those within

the regulated sector, relative to those
providers just outside, incentivising
financial flows towards the
unregulated — what Professor
Charles Goodhart calls the
“boundary problem”.

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Finding the right balance and
identifying risks is inherently difficult.
But the initial Fed proposal suggests
the boundary could shift significantly
— a boon to private credit players, and
perhaps international banks.

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Meanwhile many of the issues
which led to SVB’s failure — poor
supervision, interest rate risk and
depositor concentration — are left
unaddressed in these proposals.
Absent the Basel Endgame, the
investment case for US banks has
greatly improved with the Fed
pivot to a more dovish stance on
interest rates.