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Andrey Kostin on Basel III: stricter regulation can create “new risks”

«In Russia, we need to explore and draw on the experience of Europe. To avoid global risks in the globalised economy, we need globally-agreed rules that are followed globally. If this does not happen, the risks of imbalances we have yet to experience are hazardously high. Allowing countries like Russia to benefit from the experience of its European peers is an important way to achieve this».
Andrey Kostin,
President and Chairman of VTB Bank Management Board

The risks and imbalances highlighted by the financial crisis prompted the introduction of Basel III. But as in Europe, in Russia this must be a gradual process.

Stricter regulation, even while constraining the «old» risks of imprudent lending, often creates new risks. Regulators must take care.

The Basel III regulatory framework currently under consideration does not give a comprehensive answer to the key question of whether banks operating under burdensome rules will be able to provide business with much-needed finance, especially when the massive liquidity infusion currently being provided by central banks comes to an end.

It also remains unclear whether the new rules of game actually can foster the sources of growth need to underpin the «resilient dynamism» that participants in the World Economic Forum in Davos discussed this month.

The G20 endorsed Basel III as a response to the 2007–8 financial crisis. The rationale was to mitigate the effects of the current crisis, and to prevent a recurrence of the most destructive immediate outcomes in the event of a future downturn. Five years on from the start of the crisis we are in a position to paint a more detailed picture, and to be able to adopt nuanced approach.   

We have heard numerous warnings that the higher leverage and liquidity coverage ratios imposed by the Basel III regulatory regime mean that banks will need more capital and liquid assets, thus driving up the cost of lending. Proponents of tighter regulation, on the other hand, pointedly note that more expensive borrowing will add impetus to the deleveraging process, which is vital for stricken corporate and sovereign debtors.

The crisis had an acute effect on commodities-driven economies with less developed financial sectors, Russia included. But these countries also rebounded quickly. For them, a key outcome of the crisis was to underscore the need for further diversification rather than stricter regulation. In fact, Russia would likely find it easier to introduce Basel III requirements than many developed economies, as the country already has higher capital requirements for banks than elsewhere.

Under Basel II, the minimum capital adequacy ratio is set at 8 per cent, whereas the Russian Central Bank has a requirement of at least 10 per cent. For banks that are covered by the country’s deposit insurance scheme the threshold is even higher, at 11 per cent. VTB for example had a capital adequacy ratio of more than 12 per cent as of 1 January 2013. Were Basel III to be introduced in Russia tomorrow, the systemically- important banks would not have to raise new capital to meet its requirements.

But in looking at the possible impact of Basel III on capitalisation needs and lending costs, we must not forget that Russian and European banks face different sets of challenges. Russia has still not fully introduced Basel II, and we still have a long way to go to reach Basel III. Europe has already started on this journey, but the timetable for implementing the new requirements has already been pushed back by one year.   

Our European peers understand that there is no need to push too hard on Basel III implementation. As recently reported, the new liquidity requirements will not be fully enforced until 2019 — four years later than originally planned — and will be more flexible, with more asset classes counting towards banks’ capital buffers.

I think that this decision is balanced and rational. In Russia, we need to explore and draw on the experience of Europe. To avoid global risks in the globalised economy, we need globally-agreed rules that are followed globally. If this does not happen, the risks of imbalances we have yet to experience are hazardously high. Allowing countries like Russia to benefit from the experience of its European peers is an important way to achieve this.

The Davos meeting gave delegates from emerging markets, including Russia, the opportunity to hear from their European colleagues how they plan to implement Basel III while at the same time allowing their countries’ economic potential to grow. We must watch Europe closely because, as I have already said, the most important thing when introducing new standards in the Russian and global banking systems should be to do no harm.

One could even cast doubt on the very possibility of restoring confidence in financial markets, as they are frequently seen as irrational. We all remember Keynes’ warning that markets can stay irrational longer than investors can stay solvent. So the ultimate goal is to restore confidence in solvency, both sovereign and private. To this end, global financial regulation should be appropriately balanced and evenly enforced to ensure financial institutions remain durably solvent and prosperous.

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