New Reforms Could Make Banks More Vulnerable

The review of global banking regulation that began in the aftermath of the financial crisis is nearing completion. The Basel Committee on Banking Supervision has not been able to reach a final agreement despite the urgent need. Nobody disagrees on the goal or the main instrument: to strengthen financial stability through higher and more robust capital requirements. But achieving the objective of stability depends in part on getting the composition of capital requirements right. Unfortunately, current proposals fall short.

To see why, it’s important to consider that capital requirements come in two forms: minimums and buffers. How requirements are divided between the two can make a world of difference. Proposals currently debated in Basel will, if adopted, shift capital requirements away from buffers and towards higher minimum requirements. That will make banks more vulnerable to crises and reduce banks’ ability to serve customers when it is most needed.