Daniel W. Drezner

Here’s something you don’t see every day in the global political economy

While Occupy Wall Street has been garnering many headlines with outrage about the financial sector, the Bank of International Settlements just released a paper that’s likely to have more actual impact on said financial sector.  The paper is an effort to estimate the costs and benefits from requiring global systemically important banks (G-SIB’s) to increase their ...

While Occupy Wall Street has been garnering many headlines with outrage about the financial sector, the Bank of International Settlements just released a paper that’s likely to have more actual impact on said financial sector.  The paper is an effort to estimate the costs and benefits from requiring global systemically important banks (G-SIB’s) to increase their capital buffers.  From the executive summary: 

[R]aising capital requirements on the top 30 potential G-SIBs by 1 percentage point over eight years leads to only a modest slowdown in growth. GDP falls to a level 0.06% below its baseline forecast, followed by a recovery. This represents an additional drag on growth of less than 0.01 percentage points per year during the phase-in period. The primary driver of this macroeconomic impact is an increase of lending spreads of 5-6 basis points. Soon after implementation is complete, growth is forecast to be somewhat faster than trend until GDP returns to its baseline. The aggregate figures conceal significant differences across countries, which reflect differences in the role of G-SIBs in the domestic financial system and in current levels of bank capital buffers. International spillovers are also important, and in some countries are likely to be the dominant source of macroeconomic effects.

The overall results are robust to variations in key assumptions. Using a longer list of banks, scaling by assets rather than lending, shortening the implementation period, or limiting the ability of authorities to offset slower growth with monetary or macroprudential policy were all found to increase the growth impact, but not markedly.

What will be the effect of the full package of the Basel Committee’s proposals for stronger capital requirements – the set of buffers that will be required of all banks under Basel III, combined with the additional buffers to be carried by G-SIBs? The impact of the Basel III proposals, using the end-2009 global capital levels as a starting point, was calculated by the MAG [Macroeconomic Assessment Group] in 2010. On top of this, we assume for illustrative purposes that the top 30 G-SIBs will need to raise their capital ratios by an additional 2 percentage points, and that both parts of the reform are implemented over eight years. Adding together these two components, we find that the impact is again quite small, with GDP at the point of peak impact forecast to have fallen 0.34% relative to its baseline level. Roughly 0.04 percentage points are subtracted from annual growth during this period, while lending spreads rise by around 31 basis points. As before, different assumptions lead to different effects, with faster implementation or a weaker monetary policy response increasing the impact on GDP.

The benefits of the G-SIB framework relate primarily to the reduction in the exposure of the financial system to systemic crises that can have long-lasting effects on the economy. The LEI estimated the benefits of Basel III by multiplying the degree to which it reduces the annual probability of a systemic crisis, by an estimate of the overall cost of a typical crisis in terms of lost output. Drawing on the [Basel Committee Long-term Economic Impact Study’s] results, the MAG estimated that raising capital ratios on G-SIBs could produce an annual benefit in the order of 0.5% of GDP, while the Basel III and G-SIB proposals combined contribute an annual benefit of up to 2.5% of GDP – many times the costs of the reforms in terms of temporarily slower annual growth.

Let me just translate how the BIS would put this to a lay audience:

Hey, you know how Jaime Dimon and all the other bankers who contribute to the Institute for International Finance, American Bankers Association, and Financial Services Forum keep saying that raising their capital requirement is "anti-American" and will lead to catastrophic economic consequences?  Yeah, well, they don’t know what the f**k they’re talking about.  Raising their capital requirements causes a extremely small dip in expected growth — and by small we mean less than one tenth of one percent of GDP.  This is massively outweighed by preventing the expected lost output that would result from recessions triggered by another financial crisis. 

Now, it’s not terribly surprising that global regulators will say that they’re right and the banks are wrong.  One would expect that the interest group power of Wall Street, however, would have the upper hand.  What is surprising, as the Wall Street Journal‘s Sara Schaefer Munoz notes, is that the banks seem to be losing their battle with regulators:

The tug-of-war between banks and regulators over post-crisis financial rules has so far moved in the watchdogs’ favor with banks largely failing to upend the tougher proposals in the U.S. and Europe….

Even before Monday’s report, regulators didn’t seem responsive to the industry’s arguments. In the U.S., lawmakers have already determined that the country’s big banks must hold more capital, but haven’t yet specified how much.

The Dodd-Frank financial overhaul law, enacted more than a year ago, mandated many new restrictions on banks but left it to regulatory agencies to write the rules. Wall Street and the financial industry have spent millions of dollars lobbying to shape the rules, with little success so far.

They lost in their efforts to block new limits on the fees they can charge merchants when consumers use debit cards. Regulators are expected to vote Tuesday to issue a proposed "Volcker Rule," a part of the Dodd-Frank law designed to curtail trading activities at bank. Now they appear likely to fail in their efforts to block or water down a rule requiring them to hold extra capital.

In 2010, securities and investment firms spent a record $101.6 million on lobbying, up from $92.3 million in 2009, according to the Center for Responsive Politics. Through early October 2011, the firms had shelled out $49.5 million.

There are plenty of ways in which large banks can continue to fight the suggested rules, particularly on the implementation side.  Still, this is not how open economy politics traditionally works.  Traditionally, bank preferences are communicated to national governments, which then get expressed in BIS/Basle Committee meetings.  This certainly happened in the actual Basel III negotiations.   This kind of back and forth, in which regulators appear to trump the arguments of the financial sector, is highly unusual. 

I confidently predict that this post will not generate the kind of comments that, say, an Occupy Wall Street post has in the past week.  That’s kind of a tragedy, because this ongoing tug of war between the BIS and IIF will likely have more far-reaching consequences than anything those protestors achieve. 


Daniel W. Drezner is a professor of international politics at Tufts University’s Fletcher School. He blogged regularly for Foreign Policy from 2009 to 2014. Twitter: @dandrezner

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