Basel III Barks Up the Wrong Tree

By Eric Jackson
RealMoney Contributor
9/13/2010 5:00 PM EDT
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All the bank stocks are rallying this morning on news that the Basel III requirements are not as taxing as feared. Many analysts are applauding the new rules, saying that the Basel Committee struck the right balance between stability and growth. The committee did no such thing, in my view, because these new standards will have no bearing on causing future growth or preventing future crises.

The new rules which came out yesterday in the Basel Committee press release state that banks with now have to put aside 7% in capital for every loan they make. What's more, the banks will have eight years to get in compliance with this new standard. This 7% includes a 2.5% "buffer," which, I suppose, suggests that the committee believes it's really unnecessary. It's like the committee is saying that this buffer is the equivalent of putting banks under "extreme stress tests."

The market feared much higher levels than 7%, thus leading to this morning's rally. But, put another way, 7% capital requirements really mean that for every $1 in deposits, banks can make $14.29 in loans -- eight years from now.

Perhaps the Basel Committee thought 20:1 leverage -- when banks were asked to set aside only 5% of their capital on loans -- was perfectly acceptable and now 14:1 is severely conservative. Maybe when you compare it with the 25:1 ratio carried by Goldman Sachs (GS - commentary -Trade Now) or the 32:1 ratio carried by Morgan Stanley (MS - commentary - Trade Now) back in 2007, these new standards seem austere.

Yet the Canadian banks such as Royal Bank(RY - commentary - Trade Now), Bank of Nova Scotia (BNS - commentary - Trade Now), Bank of Montreal (BMO - commentary - Trade Now) and Canadian Imperial Bank of Commerce(CM - commentary - Trade Now) have current leverage ratios (and did through the crisis) of 21x, 23x, 19x, and 29x respectively. Yes, you read that last one correctly: Canadian Imperial Bank of Commerce has a current leverage ratio of 29:1.

I thought the Canadian banks were the ones we were supposed to emulate. I thought they were smart. I thought they were conservative. They had a single regulator who was on the job. Even men's magazines are writing articles declaring these obvious facts, so it must be true.

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