Basel III Represents Test for U.S., G-20

Basel III Represents Test for U.S., G-20

On Sept. 12, after months of negotiations, the Basel Committee on Banking Supervision, a historically low-profile international institution, announced that its participants had agreed to new international minimum capital standards for banks. Scheduled to be phased in carefully over the next eight years, the new agreement -- informally referred to as Basel III -- represents the most significant set of international financial regulations to emerge since the onset of the global financial crisis. Yet, to succeed, Basel III depends entirely on national governments voluntarily following through on implementing and maintaining the new standards. As a result, distributional consequences across countries and the lack of an enforcement mechanism threaten the nascent agreement's prospects.

The Basel Committee, comprised of the central bank governors of 27 major economies, including the entire G-20, crafts international banking standards and guidelines that member countries are expected to implement individually. The new agreement more than doubles the previous international standard for capital adequacy requirements -- or the amount of capital banks need to hold in relation to outstanding loans -- to 7 percent. The new framework will be presented at the November G-20 summit in Seoul, South Korea, where endorsement is expected.

Requiring banks to keep more cash on hand is intended to have at least two stabilizing effects. First, it will increase the likelihood that they remain liquid enough to cover losses when investments do not pay off, theoretically reducing the likelihood of future system-wide government bail-outs. Second, it should modestly limit high-risk lending.

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