‘Basel cliff’ looms for community banks

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John Berlau
Senior Fellow, CEI
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      John Berlau

      John Berlau is director of the Center for Investors and Entrepreneurs at <a href="http://cei.org/">CEI</a>. He is also a contributor to OpenMarket.org. Berlau has written about the impact of public policy on entrepreneurship for many publications including The Wall Street Journal, Barron's, Investor's Business Daily, and National Review. He has been the guest on many radio and television programs including MSNBC's "The Situation" with Tucker Carlson and CNBC's "Street Signs" with Ron Insana, and the Your World with Neil Cavuto on Fox News.

      Berlau previously was Washington correspondent for Investor's Business Daily and a staff writer for Insight magazine, published by The Washington Times. In 2002, he recevied Sandy Hume Memorial Award for Excellence in Political Journalism from Washington's National Press Club . He was a media fellow at the Hoover Institution in 2003. Berlau graduated from the University of Missouri-Columbia in 1994 with degrees in journalism and economics. He is the author of the book Eco-Freaks (Nelson Current, 2006), which has been in Amazon's top 100 best-selling non-fiction books.

As if the “fiscal cliff” were not enough, banks of all sizes — and in turn the consumers and businesses that rely on their credit — also face the “Basel cliff.”

The Basel cliff is not a precipice in Switzerland, the beautiful country in which the city of Basel is located. Rather, the term refers to the potential economic fallout from the implementation of the Basel III agreement, an international accord that is supposed to make the international banking system more stable. Unfortunately, Basel III is likely to dramatically increase the costs of mortgages and small business loans while making the banking system less stable.

The U.S. plans to begin implementing Basel III as early as January.

The Basel rules are unusual for a number of reasons: their stringency, their complexity and — in a sign of hope their unpopularity with many members of both parties. The entire Maryland congressional delegation, mostly consisting of liberal Democrats such as House Minority Whip Steny Hoyer and House Budget Committee Ranking Member Chris Van Hollen, recently wrote of their concerns in a letter to regulators at the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency.

The lawmakers stated, “We strongly encourage you to avoid needless complexity and consider the impact any new framework will have on traditional depository institutions that provide credit to consumers and small businesses in our communities.”

The Competitive Enterprise Institute (CEI), where I work, co-signed a letter to the Senate Banking Committee, along with groups representing many sectors of industry, including the U.S. Chamber of Commerce, the Property Casualty Insurers Association of American and the National Association of Home Builders. The letter argues that the Fed, FDIC and Office of the Comptroller “have failed to consider the impact of Basel III upon Main Street businesses.”

What’s more, given what we now know about our financial system’s vulnerabilities, it’s clear that Basel III’s logic is extremely unsound. Under the accord, a U.S. community bank would have to put up much less capital to buy a teetering European bond than it would to make a mortgage or business loan to a customer it has dealt with for years. As The Wall Street Journal noted in a recent editorial (subscription required):

“Their new rules encourage banks to load up on sovereign debt. This makes perfect bureaucratic sense, since the world’s governments have proven to be hands down the issuers with the most dishonest accounting. The FDIC’s own director, Thomas Hoenig, sees in Basel III the same complicated system for judging risk that failed in Basel II ‘but with more complexity.’”

Basel III also imposes one-size-fits-all standards without accounting for underwriting standards and the quality of a borrower. A bank making a mortgage with any type of balloon payment — or adjustable interest rate — may be required to carry 200 percent extra capital to cover the loan. Yes, in the past, subprime operators have made adjustable-rate loans to borrowers with bad credit, but community banks have also made adjustable-rate loans to borrowers with stellar credit.