Banks unprepared for next financial crisis, warns new report

European policymakers are being urged to make banks more resistant to potential shocks in case of another financial crisis in the future.

In a newly released report, Finance Watch called on decision makers to heed the lessons of the 2008 crash which, it said, has now “largely faded” from memory.

Amid new challenges, the non-governmental organisation (NGO) warned that “global cooperation has increasingly given way to competition”.

In particular, it highlighted the lack of progress on Basel III, an accord created after the financial crash to protect against future crises.

This complacency, Finance Watch argued, comes despite recent warning signals.

“A timely wake-up call from the collapse of Crédit Suisse and the series of bank failures in the US, including Silicon Valley Bank, has not been heard,” said Christian M. Stiefmüller, Finance Watch’s senior research and advocacy adviser at Finance Watch.

“Instead of making it easier for jurisdictions to buy into a global consensus, the excessive complexity of Basel III seems to have had the opposite effect. Major jurisdictions, including the EU, seem to be moving away from even the modest achievements under the Basel III agreement.”

Shortcomings of the Basel framework

Basel III, published by the Basel Committee on Banking Supervision (BCBS), seeks to ensure banks have enough money stashed away for emergencies.

Specifically, the accord raised capital, liquidity, and leverage requirements, intending to limit risky banking practices.

In its most recent report, Finance Watch outlined the shortcomings of the current framework.

One complaint relates to a regulatory grey zone, as the accord applies to “internationally active” banks – but does not specify further than this.

The report also questioned whether Basel III has become “too complex to be effective”.

Uncertainty over ‘buffer’ requirements

Many institutions seem unsure on the practical use of the Combined Buffer Requirement (CBR), said Finance Watch. The CBR is a cushion of capital that banks must hold on top of their minimum capital requirements. 

“When banks were encouraged during the Covid-19 pandemic to make use of their buffers a lively debate ensued, revealing much uncertainty about the practical use of these buffers,” noted the NGO.

“It seems that a degree of ambiguity about the real nature and purpose of individual buffers in the Basel III framework, and the absence of a clear distinction between structural and cyclical components, may have raised unrealistic expectations as to their usability.”

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Another major concern relates to banks using their own internal models to calculate risk.

While this allows institutions to make risk assessments relevant to their own practices, the flexibility is arguably undermining Basel’s aims.

Pushback from institutions

“Finance Watch calls upon European policymakers, both at the Union and member-state level, to reinforce their commitment to the Basel process and re-engage proactively with their partners, especially in the US, to prevent a regulatory ‘race to the bottom’,” said the NGO in Tuesday’s report.

A key proposal relates to the simplification and harmonisation of rules, which would ensure a level playing field for internationally active banks worldwide.

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Calls for tighter supervision and safety cushions are, however, faced with fierce opposition.

Earlier this month, the Federal Reserve reduced a proposed increase to capital requirements for the largest US banks.

A suggested 19% rise was watered down to 9% in response to industry pressure.

EU progress on financial regulation

In the EU, meanwhile, a recent report from former Italian PM Mario Draghi suggested that the bloc’s application of the Basel framework is overly restrictive.

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“The EU has a wide array of prudential regulations derived from the international standards set by the Basel committees,” Draghi noted in the report on European competitiveness.

“Prudential regulation is crucial in safeguarding financial stability. However, the EU has been accused of ‘gold-plating’ the Basel framework, leading to an overly restrictive and cautious regulatory environment for banks.”

Finance Watch said that this final claim is “misleading”, arguing that “in reality, the EU is at risk of non-compliance with Basel standards”.

The UK has similarly watered down plans relating to the Basel framework in pursuit of growth and competitiveness.

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The BoE’s Prudential Regulation Authority (PRA) said earlier this month that capital requirements for UK banks would remain “virtually unchanged”, with “an aggregate increase of less than 1% from January 2030 when the transitional arrangements come to an end”.

This is down from an earlier suggestion of 3%.