|Basel III and the global reform of financial regulation: how should Africa respond? a bank regulator’s perspective
Louis Kasekende, Justine Bagyenda and Martin Brownbridge
The global financial crisis has spurred an urgent review of bank regulatory frameworks to enhance the resilience of financial systems and institutions. It revealed the strong inter-linkages between the financial systems of the developed countries and those in emerging and developing markets and exposed the weaknesses of existing prudential regulations in safeguarding systemic financial stability. As a result, reforms are necessary to rectify flaws in the current regulatory framework. The Basel Committee on Banking Supervision (BCBS) is leading efforts to reform the global regulatory framework. In December 2010, BCBS announced proposals that have been dubbed Basel III, which national regulators and regional supervisory organizations are reviewing to evaluate their suitability to conditions in their own financial systems.
Key lessons from the global financial crisis revolve around leverage, capital and liquidity. Many banks entered the crisis with too much leverage, too little capital and inadequate liquidity buffers. Therefore Basel III emphasizes these three issues. This paper assesses the relevance of Basel III reforms for Africa. The focus of the Basel III reforms is strengthening capital standards. Most African banks already hold capital in excess of global standards. However, given that banks in Africa face much greater volatility in the value of their assets, an effective prudential regulatory regime must also include restrictions on the risk exposures in banks’ asset portfolios.
Basel III introduces macroprudential measures for the first time in global bank regulation. Macroprudential regulation is relevant for Africa but the proposals in Basel III are unlikely to be adequate to mitigate systemic risks on the continent, especially because they do not address systemic threats arising from cross border capital flows mediated through the banking system. As a consequence, the regulatory challenges facing Africa require a wider array of instruments than those presented in Basel III, such as regulations to restrict large loan concentrations and foreign exchange exposure. This may call for a more intrusive regulatory regime to ensure a more robust and resilient financial system in Africa.
The global standards which have shaped bank regulation over the last two decades have been found wanting, unable to prevent the most severe systemic global financial crisis since the 1930s (Blinder, 2010). This has prompted efforts to reform bank regulation, to forestall any recurrence of financial crisis. In December 2010, the Basel Committee on Banking Supervision (BCBS) issued reforms to global regulatory standards, dubbed Basel III, which include the strengthening of capital adequacy requirements, as well as the introduction of liquidity requirements and countercyclical macroprudential measures (Basel Committee on Banking Supervision, 2010A). Other reforms are still under discussion, such as more stringent prudential requirements for systemically important financial institutions (SIFIs).
Banking is an international business. Finance flows across borders and in many countries international (cross border) banks hold a prominent share of the banking market. Africa is not an exception to this. The international character of banking provides a clear rationale for global minimum regulatory standards, especially to avoid regulatory arbitrage, whereby banks locate in the jurisdictions with the least onerous regulations, spurring a race to the regulatory bottom. Hence key regulatory innovations – notably the Basel Capital Accords – have been drawn up at the global level (by the BCBS) and most governments around the world, including those in Africa, have incorporated them into their own national banking regulations. Similar principles will apply to Basel III and any other proposals for the reform of bank regulation which are eventually agreed upon at the global level. Although these reforms were developed in response to the financial crisis in advanced economies, and African bank regulators had little influence in shaping them,1 they will be regarded as a global minimum standard which should be eventually adopted by all countries.
The aim of this paper is to assess the implications of Basel III for bank regulation in Africa. We address two questions. First, are the specific proposals in Basel III relevant for Africa and are they likely to be helpful or counterproductive? Second, are there aspects of regulatory reform which are important for Africa, because of the specific nature of the regulatory challenges it faces, which are not included in Basel III? Hence are the Basel III reforms in someway incomplete from the standpoint of Africa’s needs? Our paper aims to help fill a gap in the literature on the latest global reforms to bank regulation; very little of which has assessed these issues from the standpoint of developing countries.2
The paper is organised as follows. Section 2 briefly reviews the Basel III reforms and highlights the other reforms currently under discussion. Section 3 analyses the relevance for Africa of the proposed reforms to the quantity and quality of regulatory capital. Section 4 examines the relevance of the liquidity requirements proposed in Basel III. Section 5 evaluates the Basel III reforms which are intended to introduce macroprudential regulation into the regulatory toolkit, and asks whether they are likely to be adequate to protect African financial systems against systemic threats. Section 6 addresses issues pertaining to the regulation of international banks. Section 7 provides a conclusion.
Before proceeding a few remarks about the nature of the regulatory model which is being reformed are pertinent. Over the last two decades, bank regulation in the advanced economies has focussed mainly on setting capital adequacy requirements for banks, in line with the global minimum standards set out in the Basel I Capital Accord, which was issued in 1998, and then Basel II, issued in 2006, which aimed to more closely align capital requirements with the risk incurred by a bank. Bank regulations have largely avoided imposing quantitative restrictions on the composition of banks’ assets and liabilities or their business activities; in many countries regulatory reforms have radically liberalised restrictions on banking activities, as for example with the enactment of the Gramm-Leach-Bliley Act in 1999 in the United States.3 Instead bank regulators have put more emphasis on the supervisory monitoring of banks’ risk management. This has reflected the evolution of regulation from a framework which is compliance driven (i.e. regulators focus on checking that banks comply with regulations) to one which relies more on the judgement of regulators, especially in regard to the risk management of a bank and the quality of its directors and senior managers.4 The focus of Basel III is mainly (although not entirely) on the strengthening of capital adequacy requirements as the primary quantitative tool for ensuring both microprudential and macroprudential regulation.5
Most African countries have implemented the Basel I Capital Accord.6 Bank regulation in many African countries has differed from the model practised in most advanced economies in two respects. First, stricter minimum capital adequacy requirements have been imposed. More than a third of African countries impose a higher total capital to risk weighted assets requirement than the 8 percent minimum in the Basel Capital Accords (table 1). This is not incongruous with the Basel Capital Accords, because the accords are intended to be global minimum standards and national regulators have the discretion to impose higher standards if warranted. Secondly, a broader range of restrictions on the composition of banks’ assets and liabilities and their business activities have been retained in Africa. For example, many Africa countries impose restrictions on banks’ large loan concentrations, foreign exchange exposures and business activities which fall outside of traditional commercial banking. They also impose minimum liquid asset requirements and more stringent loan loss provisioning requirements than is the case in advanced economies. As a consequence, one can argue that African bank regulation is more robust than that which prevails in the advanced economies in that the former relies less exclusively on just one regulatory instrument, the capital adequacy requirement, which in the advanced economies proved very vulnerable to “gaming” by banks to lower the amount of capital they had to hold.