US learns to play the Basel game

Mnuchin report marks a US regulatory shift – from leadership to gamesmanship

Steven Mnuchin, the US Treasury secretary, called for 102 cuts to be made to the country’s banking rules in his long-awaited report on June 13, but this was deregulation by the scalpel, not the axe.

Rule by rule, point by point, the report would pare back gold-plated US rules, leaving them in line with standards agreed at international bodies such as the Basel Committee on Banking Supervision (a detailed analysis is available here).

This did not seem likely a few months ago. In January, Patrick McHenry, the Republican vice-chairman of the House Financial Services Committee, wrote to Federal Reserve chair Janet Yellen, instructing her to stop “negotiating international regulatory standards for financial institutions among global bureaucrats in foreign lands” and wait until President Donald Trump had been able to “nominate and appoint officials that prioritise America’s best interests”.

Six weeks later, Republican senator David Perdue claimed the US version of the Basel rules was “extremely dangerous”. Both politicians argued US regulators were holding back the country’s economy – a view President Trump shares, according to Perdue. 

Despite this backdrop, the US Department of the Treasury has resisted the temptation to chop down the regulatory thicket and is seeking to prune it instead. It is tempting to view this as an endorsement of global banking standards, but that isn’t quite right. 

No-one should be fooled into thinking this equalises the playing field for European and US banks

No-one should be fooled into thinking this equalises the playing field for European and US banks – the US is not the only country to gold-plate its version of the Basel framework. Switzerland and the UK both went well beyond the 3% leverage ratio minimum; Sweden and the UK have applied floors to elements of their risk-weighting systems; and some countries in Asia and Europe have activated Basel III’s countercyclical capital buffer, forcing their banks to meet a higher capital minimum, if only temporarily. 

There are also elements of the capital framework which – though agreed internationally – disproportionately benefit certain markets. The package of measures under discussion at the Basel Committee contains what one observer describes as a “huge capital giveaway” for US banks, in the form of a 75% risk weight for exposures to unrated small and medium-sized enterprises in jurisdictions such as the US, where the use of external credit ratings to calculate regulatory capital is forbidden. There were even rumours at the end of last year that this could be cut further, to 65%.

By contrast, unrated corporate exposures in Europe, where the standardised approach to credit risk capital is based on external ratings, would carry a risk weight of 100%.

And then there is the thing that has made it so difficult for Basel members to agree that final package – the state-backed mortgage finance system in the US, which means the country’s banks have much smaller books of home loans than their European counterparts, and therefore benefit less from the system of capital modelling that the US is trying to curb. A leaked letter from Basel Committee chairman Stefan Ingves to its members suggests credit risk weights for mortgages have been a significant bargaining chip in the negotiations.

Reading between the lines of Mnuchin’s report, the judgement appears to have been that the US can play the good international citizen without hurting its banks and – in some cases – preserving the advantages they enjoy. It marks a radical shift in the country’s post-crisis regulatory philosophy – from leadership to gamesmanship.

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