Over the past few decades, banking systems globally have undergone rapid evolution, driven by market-oriented advancements. These advancements encompass the introduction of increasingly sophisticated banking products, integration of information and communication technologies within banking sectors, and the expansion of banks into diverse financial services like asset management, insurance, securities underwriting and trading, foreign exchange trading, and more. Despite all those complexities and internal risk models they employ, banks still just serve as intermediaries, facilitating the flow of funds from savers to borrowers to fuel economic expansion and consumption growth. This process plays a pivotal role in achieving efficiency in financial markets. Modern banking, however, allows them to extend beyond their traditional roles of deposit-taking and lending and act as an intermediary that enters the bank into transactions that might carry inherent risks (WeWork comes to mind). Enter player two – regulatory bodies such as the FDIC, Fed, etc. have also played a crucial role by formulating and implementing policies, institutional frameworks, and regulatory measures to facilitate banking sector liberalization, integration, and enhanced stability. As a result of these developments, the interaction between savers and investors through financial intermediation has gone to the point of being so dynamic, that tweets and subreddits have been perceived to have the power to impact markets.
The debate surrounding bank regulations and enhanced supervision is a topic of intense discussion within policy circles. Empirical evidence suggests that excessive bank regulation could have unintended consequences, potentially counteracting its positive impacts on governance and the development of the banking sector. The existing literature highlights that a heavily regulated environment, while theoretically capable of mitigating informational imbalances and issues, doesn’t inherently ensure robust bank valuation, stability, and growth. This is attributed to the myriad of channels through which regulations and policies influence various outcomes in the banking sector, including factors like ownership structure and corporate governance. While regulations typically aim to mitigate unnecessary risks, crises can be triggered not solely by banks’ risky activities but also by lack of confidence in national institutions due to negative perceptions.
However, in the present moment, the US banking sector is grappling with formidable challenges and cannot time an update to their existing regulatory framework any better. The ongoing global economic uncertainty, stemming from factors such as the taming of inflation and the fragile recovery of the Chinese economy, has exerted pressure on banks, impacting their operations and credit creation. Just in time for the Fed, FDIC, and Office of the Comptroller of the Currency to release their proposal to update the existing regulatory framework, focused on capital adequacy and liquidity of banks. Which some other countries have started implementing as the proposed adjustments is the final component of Basel III, which the finance gurus in Fed refer to as the Basel III “endgame”. This aims to update how banks should aggregate and compute for the RWA computation that goes into their Tier 1 capital requirements. In short, the proposal tells banks with $100 Billion or more in total assets to consider more risks without adjusting the minimum capital requirements and the inclusion of unrealized gains and losses from certain securities in the bank’s capital ratios and will start implementation by July 2025 and full compliance by July 2028.
Hopefully, the precarious phase that the global economy is in due the COVID-19 pandemic which weakened and caused uneven economic activity worldwide, Russia-Ukraine war, inflation, amplified downside risks, and declining investor confidence won’t adversely affect the full implementation of Basel III and inadvertently add a GSIB to the ranks of SVB, First Republic Bank, and Signature during the upcoming implementation phase.