How Basel III will affect bankers and consumers

A bank sign


Kai Ryssdal: Think for a second about the global economy -- in particular, the financial system -- and then ask yourself this question: Does it work? Does the giant network we have of banks and consumers and businesses do what it's supposed to do, let people get their hands on the money they need to buy and sell and, over the long run, thrive?

The honest answer is not really. So today we're going to start a new series about the search for a better financial system. It's called Economy 4.0 and the guy who's going to be doing it is a guy you might've heard of, former Marketplace host David Brancaccio.

David, welcome back.

David Brancaccio: Great to be here, Kai.

Ryssdal: Economy 4.0, what's it all about?

Brancaccio: It's about what comes next after the financial system's, call it, "near-death experience." Can the economy be re-engineered to better serve more people?

Ryssdal: And you're breaking it down two ways, yeah?

David Brancaccio: Yeah. There will be enormous shifts, I think, in money and power as financial rules in the U.S. and around the world get shaken up and rewritten. We need to watch this to understand whose interest is being served. Other stories in this Economy 4.0 thing are about alternative ways to measure the economy. If we want a brighter future, maybe we should do a better job accounting for things like well-being, not just the quarterly ups and downs of GDP.

Ryssdal: And today we have a story about one global banking reform that affects us down to our branch offices.

David Brancaccio: Let us start with the Swiss city of Basel. It's home to a kind of a club for the world's central banks. The group's been working on what some have called the most important worldwide response yet to the financial meltdown. It's about new rules for banks. The nickname is "Basel III."

Mike Konczal follows this at the Roosevelt Institute here in New York.

Mike Konczal: It's been a thankless chore, but it is very important for future of the financial sector's stability and how well the banks can survive the next crisis.

He says the stricter rules are about stopping another panic like we saw after Lehman Brothers collapsed two years ago.

Konczal: What happened was Wall Street all showed up at the same time and they wanted their money back.

Not enough cash was available, sparking the kind of crisis Basel III is meant to prevent. These new rules should be ratified by leaders of the world's major economies in November.

Konczal: So what does Bay-sel III do? I should say Bah-sel, right?

Either way. By far, the biggest thing it does do is force banks to build up their cushions of cash and other capital and keep it ready for action, just in case. These days, banks have to hold $2 for every $100 they lend out. Under new rules, typically banks will need $7 on hand. A key change: That bigger pad of money now has to be easy to get to in an emergency, not tied up in some investment lock box when a bank really needs it.

These rules have real consequences and not just for fancy bankers.

Sound of power tools whirring

Kelly Conklin: We're getting a nice rhythm going on this project, finally.

Kelly Conklin is owner of a cabinet-making business in Bloomfield, N.J. Foley-Waite Associates has 13 employees, currently at work on teak cabinets for some rich guy's yacht. Does Basel III come up a lot around his kitchen table?

Conklin: Haha no, no.

Conklin laughs

What does come up is the state of the banks Basel III's supposed to stabilize. During this time of tight credit, Conklin says he's not feeling the love when he tries to get a business loan.

Conklin: The idea that we are now asking the banks to act responsibly and hold sufficient funds in reserve so they don't get in trouble, so we don't have to bail them out. I mean, you know, follow the logic here: They get in trouble, we bail them out. We're in trouble, because they got in trouble. And now when we go ask them for help they tell us, "Sorry, can't help ya."

Conklin is active in a small business network called the Main Street Alliance. He hears story after story of decent businesses like his wrestling with banks in little mood to lend. He's worried Basel could make things worse.

Conklin: I think the concern might be it will slow the availability of credit just when the economy's about to take off. And that's a problem for those guys to solve. That's way above our pay grade.

Sharing the cabinet-maker's worry is a banker, Jesse Torres, CEO of Pan American Bank with three branches near Los Angeles. He, too, is concerned about the higher cash reserves.

Jesse Torres: That really affects our ability to lend. It forces us to keep more money in the vault as opposed to making that money available for loans.

Torres runs a tight ship serving mainly lower-income Latino customers and his foreclosures have been practically nil. Still, he's worried some of his investors will be scared away if his money is trapped in his bank and not making better returns in higher-yielding investments.

Matthew Bishop at The Economist magazine offers this showstopper about Basel. Remember Lehman, the investment bank that went bust, ending economic life as we know it?

Matthew Bishop: Yeah, Lehman quite probably would have passed the new Basel rules.

Got that? Bishop says Lehman Brothers, as it tumbled into the abyss, would have met the new capital requirements.

Bishop: I'm not sure the Basel approach is going to make another crisis less likely. It just means that during normal times, banks will not be able to lend as much.

But Mike Konczul, the man at the Roosevelt Institute who's been following Basel, disagrees.

Konczul: In general, banks being solid and well capitalized means people will be more likely to put more money in them, not less likely. The more people put money in, the more money there is for you and me to invest in our communities.

Under Basel, capital requirements phase in slowly and don't reach their full effect until 2019. In the U.S., the Fed has discretion to clamp down earlier, which it might consider, given that a new financial crisis is expected every seven years and we're already two years into this one.

In New York, I'm David Brancaccio for Marketplace.

Kai Ryssdal: It wouldn't be Economy 4.0 without a web element. Our series on how the global economy might actually work better for. on our website.

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An addendum to my previous comment (which is probably listed below this one):

Conklin's concern need not be a concern at all. Private banks aren't the only places that money is created; money is created by the government as well. Andy constriction of the money supply that comes about through an increased reserve requirement can easily be compensated for by changes in open-market operations at the fed. And when that happens, the profit from issuing the money--the seigniorage--accrues to the public, not private banks. The giveaway of seigniorage amounts to the largest ever subsidy program ever instituted ($7 trillion since the 1930s). Time to end the free ride, and move toward fiscal responsibility in Government by getting that public money back into the public coffers. departments (Central Banks and Fed

The increase in the reserve requirement is a start. If you're an optimist, you can call it a 250% increase, which sounds impressive. But it's far short of the increase that is needed to stop the economy from being built on a pyramid of unsupported debt--the structural flaw that makes regular spasms of debt repudiation a necessity. We aren't going to stop those spasms until we fix the structures that makes them necessary, and one of the main structures is Fractional Reserve Banking. Every time money is lent out at interest, it creates claims on the future production of wealth (that's what debt is). When claims on wealth exceed the capacity of the economy to grow and pay them off, sooner or later you get a crisis of debt repudiation. Ecological Economists and former World Bank chief economists Herman Daly argues that we need to phase in a 100% reserve requirement. Under such a regime, banks would no longer create money; the seigniorage from money creation would be given back to its rightful owner--we, the people, whose government guarantess the value of the money in the first place--instead of accumulating in private hands. And banks would have to make money from legitimate services like safekeeping, check clearing, and intermediating between lenders and borrowers, instead of from collecting income on loans made with money that isn't theirs. Pretty radical but when you think about it fair, honest, and necessary. Radical as it is, this concept was advanced by no less a conservative economist than monetarist Milton Freedom, back when it was called "100% money" during the Great Depression. Check it out. Maybe in a future story, David?

Once again, we're not solving the problem. The real problem is banks make risky loan and don't have enough 'reserves' to cover them. Simplify the whole thing by forcing banks to have 'appropriate' reserves according to the riskiness of their loans. And of course, don't let any one bank get too big to fail; and just let them fail if they can't meet their financial obligations - just like everyone in the owrld. When you think about it, this is not too complicated.

It is good to hear from David again! And this is a great way to focus on perhaps the most important subject in the world these days! Let's keep David on Marketplace!

If you play the numbers a bit, the increase require reserve ratio will yield to about 5% increase in returns the banks make in order to pay back to its creditors (the unfortunate and always hurting savers in the economic). While increase profit margin by 5% might not seem much, in a world of higher yield is call for higher risk (and unfortunately that is the world we live in) this will only become an incentive for bank to make more unsecure investments. Surly, banks will have more money in hand when facing crisis; (tough 7% might not be sufficient when facing a major financial crisis as the guy from Economists pointed out)but the increase reserve requirement itself is calling for more often and may be more sever crisis. In order prevent the case we discuss above from happening, government need to cap and floor the interest rate bank charge/give for its customers, along with restrictions that bar banks from participated in any investment activities the traditional banks were not use to do. So the bank will have no way to absorb this 5% increase from any kind of risky investment. Then banks will have no way out, but cutting cost (most likely through layoffs). But this will mean a full distortion of savings and loan market, and from economic 1.0 we already know that without a free market price of that reflex the supply and demand in the market, the price ceiling and floors will greatly reduce the efficiency of the society, hence slow down the much needed economic recovery.

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