A Basel III Deep Dive | What to Know About How It Will Transform Banking Globally
Episode publishedPodcast: Monetary Matters with Jack Far...Monetary Matters with Jack Farley
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Got a very important conversation today. I'm joined by Chen Xu, corporate counsel at Debavois and Plimpton. He is a member of the firm's financial institutions group and liability management and special situations team. Chen is an expert on many legal matters in corporate finance, but in particular, bank regulatory capital, which is what we're gonna be talking about today. Chen, welcome to Monetary Matters.
Thank you, Jack. Thank you, Jack. It's a pleasure to pleasure to be on.
I wanna set the stage for our audience here. We're talking about regulatory bank capital. So a lot of banks are regulated at the nation level, but there's also international bank regulation that was about Basel. So headed out out of Switzerland, there was something called Basel One, which regulates stress, you know, stress testing, how much capital banks can hold, which is very important. And then there's Basel two, which was, like, in the early two thousands. That, I think, was kind of a disaster because it had certain risk weightings that, you know, incentivized risky subprime mortgage backe
Yeah. So that's a good question. So if we rewind back to the financial crisis, 2008, 2009, the state of the industry was that they were in the middle of the process of trying to implement Basel II. Firms were fully implemented. Some of them were in process. And then the financial crisis happened, they realized, oops, I guess Basel II didn't work. We need to come up with something new and something that's less driven by models. Because that was the big issue with Basel II is that I think they gave some of the banks a little bit too much discretion as to how to model their own capital requiremen
So just to explain a few terms. So, you know, banks are leveraged institutions. They have deposits. Bank equity is how much capital banks have to have in order to take on losses because equity is the first thing to have losses. So when people say, you know, Lehman Brothers was levered 50 to one, that what that meant is that in effect, it had 2% equity against a 100% of its, total assets. So, you know, a a very conservative capital ratio would be 20%, meaning you have, as a bank, five you know, you're you're levered five to one. You, have 500% liabilities of of your equity. So and and then ther
Yeah. I would say that in 2010, and that was what happened to the Committee, and then 2013 in The US when they finalized rules based on the 2010 Basel revisions, I think we addressed most of the numerator, all the numerator stuff. So what you mentioned is how much capital do we need and percentages and what counts as capital. And then we addressed some of the denominator risk weighted asset issues, but not all of them. So we addressed most of them, and 2017 was sort of maybe the last 25% to 30% of it, where they really dug into the risk weights and tried to make sure that they were comparable
So what remains?
So after this, it's sort of like potentially further refinements. But after The US gets done with this and Europe and Japan and all these other jurisdictions, then I think we're done for now. Then maybe we turn our attention to liquidity and stress testing and things like that. But the idea is the dream is that once we get all this done and we've fully implemented December 2017, then everything is done.
Wait. So you said it was done in 2017? I what what is this Basel III endgame that remains to be implemented that people have been talking about for ten years that is is so elusive?
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