Looking ahead: where now for the Basel Committee?

When the financial crisis erupted back in 2007, the Basel Committee on Banking Supervision (BCBS) was the obvious candidate to help address the deficiencies in the banking system, as its authority is recognised internationally and it has the requisite expertise to deal with this complex global industry.

Even though the framework the BCBS put together is voluntary, its influence is very hard to ignore – particularly for global banks and their supervisors. Also, as no global regulator exists that can carry out the tasks rendered by the BCBS, setting one up would be extremely difficult, and this is a situation that is unlikely to change any time soon.

Collective views

That is all the more remarkable given that the BCBS does not even have a legal personality (unlike, say, the Financial Stability Board) and is hosted by the Bank for International Settlements. Essentially, it is a committee made up of 45 institutions in 28 jurisdictions, including the EU. “The committee represents a highly efficient centralised body for the generation of collective views on guidance,” says James Phillips, regulatory strategy director at Lombard Risk. 

However, observers believe that in 10 years' time the BCBS could look markedly different from today’s organisation. This is because there are numerous forces at work that could reshape how it makes rules, its membership and even its mandate. And this is assuming that the Basel III/IV framework is signed off within a reasonable timeframe.

Such an event would mark a major milestone for the BCBS. According to bankers, this would probably see it gradually sink into the background, essentially acting as a guardian of the Basel framework and insuring it is kept up to date and implemented properly. Besides, there is currently little global appetite for a major overhaul of Basel III/IV or to construct a completely new framework. But given its importance, particularly since the financial crisis, the BCBS is unlikely to enjoy a quiet life.

The Trump effect

A common feature of the post-crisis world is for the established order to be challenged, with the UK’s vote to leave the EU and the election of Donald Trump as US president being the two most cited examples. These trends potentially work against globalisation and could undermine international bodies such as the BCBS.

Indeed, there is a heightened risk of regulatory fragmentation as some countries are inclined to focus primarily on nationalist agendas and satisfy populist impulses at the expense of international co-operation. One challenge facing the BCBS emanates from Mr Trump’s populist administration and its ‘America first’ agenda.

Numerous senior figures in the ruling Republican party have railed against international bodies for ‘interfering’ with US financial institutions, accusing them of setting rules that stifle lending and hold back the US economy. Congressman Patrick McHenry, vice-chairman of the House Financial Services Committee, even lashed out at the US Federal Reserve for the role it plays in international standard-setting bodies.

BCBS secretary-general William Coen says: “I was encouraged by President Trump’s executive order from February 3, which articulated a set of core principles, one of which reaffirmed the active engagement of US authorities at the international standard-setting table.” The executive order outlines the administration’s core principles for regulating the US financial system. Principle ‘e’ calls for the advancement of American interests in international financial regulatory negotiations and meetings – in other words to participate, rather than shun them.

Nonetheless, there has been some lingering concern the US could walk away from the framework. In June, a report from the US Treasury entitled ‘A financial system – that creates economic opportunities’ tentatively started expanding on that core principle.

For instance, it recommended giving “rigorous thought” to the structure and mandate of standard-setting bodies, such as the BCBS, and the way they set global regulatory standards. It also contemplated narrowing their scope, focus and initiatives, and eliminating overlapping objectives. It also wants to raise their transparency and accountability so external stakeholders’ views are given more weight.

According to some industry sources, if these recommendations were acted upon – and much detail is still missing – they could result in some restructuring of the BCBS. “There are a number of deep problems with the way Basel operates that have been around for five years or so and will become more acute as time goes on,” says Paul Sharma, managing director at consulting firm Alvarez & Marsal.

Mr Sharma, who is also a former deputy head of the UK Prudential Regulation Authority (PRA) and was a Basel member, says: “Legislators in the EU and US don’t quite like it that law gets made de facto in Basel and is then presented to them, and that you have to agree to it because it is the international standard and you can't deviate or you'll be non-compliant with international standards.” He notes that this rankles particularly with the European Parliament and in some US political circles. 

Not a secret society

The terms democratic deficit and lack of accountability are often heard in reference to the BCBS. Mr Sharma says this view partly reflects the very technical nature of its work. Also, the people who draft the framework tend to be senior regulators, because they have the expertise, but are not the heads of the regulatory bodies who are typically answerable to their respective governments and parliaments.

“When it was a techie thing that was fine,” says Mr Sharma. “But banking standards have become more political over the past 10 years as the link with risks to tax payers has become much more evident and understood.”

But the BCBS believes that talk of inadequate accountability is misleading and unfair. Mr Coen says: “I feel strongly about this issue of accountability. In the past year, I’ve met with the Dutch parliament, the European Parliament’s Committee on Economic and Monetary Affairs on two occasions, the French senate and I’ve met with congressman (Jeb) Hensarling and his colleagues on the US House Financial Services Committee. We make every effort to be accessible.”

These were all occasions for lawmakers to cross-examine Basel officials about their work and its impact on banking. He adds: “We have a transparent process – we’re very open about how we operate and the status of our work. At the same time, central bank and supervisory independence is an important dimension. I think people sometimes blur the distinction between supervisory independence and transparency/accountability.” 

No doubt these encounters have done much to educate politicians about the work of the committee and dispel any concerns that it acts like some sort of secret society. It consults extensively with stakeholders on new rules, carries out quantitative impact studies to see how those rules are performing, its members speak at public events and with the media, and its mandate and operating procedures are clearly explained on its website.

Also, the committee is answerable to the group of governors and heads of supervision, whose members are subject to nomination and selection processes in their national states and accountable to their respective public institutions.

Political pressures

Nonetheless, some politicians may feel compelled to act on their public rhetoric. “[The BCBS] is going to face some pressure as to its process for consultations,” says Molly Preleski, financial services regulation expert at PA Consulting Group. She says it may have to look at its arrangements for how and when it reaches out to the public and the industry and the functioning of its working groups, and it might be called upon to interact earlier in the policy-making process.

“It could result in more consultations. Calling for evidence earlier might be another way to go; anything that would demonstrate an openness to receiving feedback and input on policies. Obviously, that has to be balanced with the fact that the BCBS is an independent organisation,” says Ms Preleski. “I think it will be a slow process. I don't see anything changing quickly in that regard.”

The risk with doing more consultations is that it could convolute policy-making and create a situation whereby each round of feedback results in diminishing returns in terms of improving the framework. Another issue that could affect the way the BCBS works emanates from what happened in 2009. That year, membership was broadened to include countries such as Australia, Brazil, China, India, Mexico, Russia, South Korea, Turkey and Saudi Arabia. Though that expansion certainly insured the BCBS’s continued global relevance, it also brought on board new interests and opinions.

According to Mr Sharma, those members have become steadily more vocal in pushing their interests and he predicts that if the traditional Europe/US axis needs to get anything agreed – and the hold-up on Basel III/IV is down to disagreements between these two blocs – they will be challenged by increasingly powerful and vocal emerging market members.

These members are primarily focused on financial inclusion and improving banking services in their countries to spur economic development, he says, while a small number of them are concerned about the treatment of Islamic banking in the Basel accords. Meanwhile, they are less concerned about the internal models so valued by the Europeans, and prefer simplicity, such as improving the sensitivity of the standardised approach without significantly complicating it.

“The old dynamic of standards getting made in Basel when Europe and the US agree wasn’t even wholly true for Basel III. The newer countries did assert themselves, but you could still recognise the contours of Europe and US agreeing,” says Mr Sharma. “Basel IV/V won’t be like that.” 

Fintech fires up

While the politics simmer away in the background, more fundamental changes are rapidly occurring that are reshaping the industry the BCBS oversees, which relate to technology. Industry sources feel this could have just as big an impact as politics on the future shape of the organisation. 

The rapid growth of fintech has the potential to rearrange much of the banking landscape as it threatens to disintermediate and marginalise banks, and create new business models and ecosystems.

“The game has changed significantly under the [BCBS’s] feet. Technology has moved forward,” says Lombard Risk’s Mr Phillips. “What I think is going to become really interesting for the committee are some of the emerging risks which are not getting an awful lot of attention.” He cites possible risks from the growth of fintech in some emerging market economies, which is bypassing banks altogether in some cases.

“The committee might be a bit behind the curve in terms of addressing future fintech risks. You’ve seen local regulators taking initial steps towards fintechs and they’re outpacing global standards,” says PA Group’s Ms Preleski. “I think it’s important to monitor the impact of fintech on banks, because there are a lot of incumbents who have business models that could be completely disrupted by developments in fintech and that might impact bank stability.”

Mr Phillips notes that national competent authorities are focusing more on fintech. He says that with so many regulators now setting up sandboxes and trying to promote fintech, some risks could get overlooked, adding: “The amount of noise in the sector is extensive. I think this could eventually become a Basel item.”

He says the distributed models that often characterise fintech potentially throw up risks at each point in the chain, such as cyber-attacks, representing potential for some form of loss. Though fintech “is nowhere near being a systemic risk yet”, he believes the area is worthy of more attention and will help the BCBS stay relevant in the future.

“Technology-related risks confronting banks are not new and I’m reminded of the guidance we published in 2003. In fact, I think we should refresh it and give it a facelift, because what we said back then is still relevant to the risks associated with technology, such as outsourcing, the adequacy of security controls, protecting customer data and governance issues around technology,” says Mr Coen.

Nonetheless, he believes not every risk can or should be regulated. “I think there is a clear understanding within the BCBS in that regard,” he says.

Heading into the unknown

And there are other considerations that may require revisiting the Basel accords at a later date. Damien Burke, head of regulatory practice at risk consultancy 4most, mentions changes in the financing landscape such as the explosive growth in payday lenders in certain jurisdictions as an example of the industry’s constant evolution.

“You’re also seeing finance being applied a lot more to everyday low-ticket items, such as washing machines, which in the past you tended to rent if you couldn’t afford to buy one outright,” he says, adding that the immediacy of credit is also changing. 

“I can’t see a world where the BCBS hangs up its coat with everything done,” says Mr Burke. What best practice will look like in 10 years’ time might be incomprehensible compared with today because of advances in computing power and connectivity, he adds. For instance, it might be standard practice to use unstructured data, such as from social media and data from store cards, as part of credit assessments.

“From the regulatory and policy side there is not much more for us to do. We will remain vigilant when it comes to regulatory arbitrage and will continue to monitor how the rules are behaving in practice,” says Mr Coen. “I can’t overstate the importance of supervision. It’s the reason for our existence and it doesn’t get a lot of attention because it is harder to quantify.”

One supervisory issue he cites is the unique interest rate environment coupled with a competitive banking market leading to questions about how banks are making money, and the sustainability of their earnings. The shared experiences of different supervisors can reveal information on such issues, he says.

Indeed, the ultimate test for the BCBS and its framework – and probably key to its future – is how the banking system fares during the next global downturn and how it responds to efforts by central banks to gradually normalise monetary policy.