Under the proposed Basel III requirements, banks are required to increase their capital levels, and big banks are required to increase their capital levels even more. The Bank for International Settlements estimates the cost of these new regulations:
Adding together these two components, we find that the impact is again quite small, with GDP at the point of peak impact forecast to have fallen 0.34% relative to its baseline level. Roughly 0.04 percentage points are subtracted from annual growth during this period, while lending spreads rise by around 31 basis points.
Well, that doesn’t sound so good. Sure, 0.04% isn’t much, but it adds up over time. I wonder if there’s any benefit to these new rules?
The benefits of the G-SIB framework relate primarily to the reduction in the exposure of the financial system to systemic crises that can have long-lasting effects on the economy. The LEI estimated the benefits of Basel III by multiplying the degree to which it reduces the annual probability of a systemic crisis, by an estimate of the overall cost of a typical crisis in terms of lost output. Drawing on the [Basel Committee Long-term Economic Impact Study’s] results, the MAG estimated that raising capital ratios on G-SIBs could produce an annual benefit in the order of 0.5% of GDP, while the Basel III and G-SIB proposals combined contribute an annual benefit of up to 2.5% of GDP — many times the costs of the reforms in terms of temporarily slower annual growth.
Shazam! A cost of 0.04% per year and a benefit of 2.5% per year. This comes via Dan Drezner, who comments that, of course, “it’s not terribly surprising that global regulators will say that they’re right and the banks are wrong.” True. But this is a massive difference. The BIS modeling would have to be off by an enormous amount for these new rules to be anything less than hugely beneficial. Basically, we’re paying a tiny amount each year in order to avoid periodic financial crises like 2008 that wipe out gigantic chunks of GDP at a single crack.
Tim Geithner may have gotten some things wrong, but his insistence on the importance of “capital, capital, capital” has been exactly right. Jamie Dimon can bluster all he wants about the new rules being “anti-American,” but the details of his complaints are trivial compared to the benefit of raising global capital levels substantially — which probably won’t hurt American banks much at all anyway. Geithner is right to stand up to Wall Street’s usual howling and charge full steam ahead with the new Basel requirements.