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Regulating Financial Markets with Basel III: Higher Global Capital Standards Announced

Yesterday, on 12 September 2010, new global capital requirements for banks were announced. The new standard (“Basel III”) was adopted by the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision. This body is generally considered the World’s main body for financial rules and supervision standards and consists of the heads of the central banks and the financial supervisory authorities of 27 countries of major economic importance (for further information see here).

The key objective of Basel III is to tighten the already existing international rules on financial regulation (“Basel I” and “Basel II”), which were perceived to provide insufficient protection against the turmoil of the financial crisis. For this purpose, Basel III will raise the existing capital requirements for banks significantly. This concerns, more specifically, the “core tier-one capital”, i.e. the Bank’s top quality capital (the Bank’s safest assets) consisting of capital equity and retained earnings. The new rules require banks to increase the percentage of the “core tier-one capital” in relation to the bank’s overall capital from now 2.5 % to 3.5 % in 2013 and 4.5 % in 2015. In addition, banks will be required to create a capital conservation buffer of another 2.5 %, which will raise the total common equity requirements to 7 %. That being said, banks will have until 2019 to bring the capital conservation buffer into place (see the press release of the Group as well as the Agreement of 26 July 2010, which contains details on the new Standard and was endorsed in the Group’s meeting of 12 September).

Commentators have referred to this new standard as “the biggest change to global banking regulation in decades” (see the coverage by Reuters). Indeed, this standard will require numerous finance institutions to raise considerable amounts of “fresh money” (Reuters speaks of “hundreds of billions of Euros”) to comply with the new regulation, depending on their current capitalization rate. It appears that German banks will be hit quite hard by the new standard while, for example, British banks will be less affected by this reform.

The new rules have stirred a lot of debate. While the supporters of Basel III argue the new standard is urgently needed to make banks less vulnerable to turbulences on the financial market, its critics point to the risk that the new rules may make banks give out less money, which may hurt small and medium enterprises in need of loans (see the Guardian’s coverage of this debate). Also, the rather generous transition arrangements that banks have been granted have been perceived by some as bowing to the financial lobby (see again Reuters for more information on this issue).

From a legal point of view, the question seems crucial how these standards will be enforced and implemented in domestic law. Some experts have doubts as to whether all the countries represented in the Basel Group will implement these new standards timely (see for example the following newspaper article (in German). Also, the Basel III rules would, most likely, not be embodied in a fully fledged international treaty but rather in soft law instruments with a rather limited supervisory mechanism. Effective implementation will therefore decisively depend on the States’ political will and on the political pressure exercised by their fellow States.

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