More on Basel III Politics

In my last Basel post I presented this argument:

It isn't an accident that the firms screaming bloody murder about Basel III are in Germany and Japan, not the U.S. and U.K. That's not to say that U.S. and U.K. banks love it, and they're certainly not going to say it, but Basel III isn't cutting into them as much as some of their foreign competitors.

But I didn't really defend it. Here's what I was talking about:

Big US banks should be able to meet tighter global capital requirements without having to raise substantial amounts of new equity, according to calculations by Barclays Capital. ...

BarCap, for example, estimates that the 35 largest US bank holding companies will need to come up with $115bn in new equity or retained earnings to bring the ratio of their equity tier one capital to risk-weighted assets – a key measure of financial strength – to 8 per cent under the revised rules.

That is about half the $225bn in new capital the biggest US banks would have had to raise under a tougher draft of the rules circulated in December, said BarCap’s Tom McGuire, whose unit did the calculations.

Similarly, Nomura analyst Jon Peace calculated that the top 16 European banks would need to raise €200bn ($257bn) to restore capital removed by the reforms, down from €300bn under the December rules.

That was written before the new estimates came out, which are somewhat stiffer than those mentioned in that article, but that would likely hurt European banks even more. Here's why:

Germany’s top 10 banks will have to raise as much as €105bn ($135bn) of fresh capital under a global regulatory overhaul, the country’s banking industry has warned, in a last-ditch effort to change tough new rules. ...

The reforms are particularly contentious for German banks because public sector groups in particular have relied strongly on instruments called silent participations, which are not loss-absorbing, making them unsuitable as top-quality capital in the eyes of the Basel committee. ...

In July, when a draft was published, Germany was alone among the 27 countries represented in saying it could not agree to tighter definitions of capital without knowing what the headline ratios would be.

Notice that under these projections the top 10 German banks would need to raise $20bn more than the top 35 American banks. The headline ratios now appear to be tougher than what they were expected to be in July. In other words, German banks are even worse off than what they probably expected just two months ago. This is a huge benefit for U.S. firms. Factor into that the new liquidity requirements -- which will hit U.K. firms much harder than U.S. firms because U.K. firms had levered-up much more than even American firms -- and the fact that the Japanese banking sector is basically insolvent by rumored Basel III definitions, and the entire Basel agreement gives American firms a huge competitive edge.

Japanese banks are particularly unhappy that under Basel III, deferred-tax assets would no longer be able to count as Tier 1 capital. ...

The tax deferral tactic started losing favor after Resona bank had to be nationalized in 2003 when its auditor wouldn't sign off on tax deferrals and its capital adequacy fell too low. Still, in 2008 roughly 100 banks counted as assets tax deferrals equal to 20% or more of their core capital, according to a Bank of Japan survey last September. The numbers had been rising for two consecutive years. In the U.S., by comparison, the Fed lets banks count the lower of either tax deferrals realized in one year or 10% of core capital.

A bigger factor, though, may be that Japanese banks have so much trouble raising any other kind of capital. Retained earnings are out because their profits are among the lowest in the world on either a return-on-equity or return-on-assets basis, according to a Bank of Japan report last month.

This is why Geithner, Bernanke, and the Obama team left capital requirements out of FinReg. They knew that a unilateral move to stricter standards would hurt American firms, while an international move would help them. Geithner believes (and I agree) that the only financial regulations that are truly essential are capital ratios. So they saved the biggest piece for last in the hopes of dumping off some of the costs of re-regulation onto foreign firms. And it looks like they succeeded.

As I said before, this isn't just about making the system safer. It's about making someone else pay to make the system safer.