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Basel III Cliff May Be Averted, But Dangers Still Loom For Main Street Banks

After numerous criticisms from U.S. community banks and lawmakers of both parties, the international committee in charge of the Basel III bank capital agreement just announced it is slightly revising the accord and delaying it for a couple more years. This action is welcome. If Basel had been implemented this year as written, it almost certainly would have thrown the U.S. and other economies into a recession more than going over the "fiscal cliff" ever would have.

But although the "Basel Cliff," as I have called it, may be averted for now, dangers still lurk in its implementation in the years to come. This is both because of the accord's wrongheaded bias in favor of sovereign debt, and because U.S. regulators have rushed headlong to push it through before congressional action that is almost certainly needed to ratify any complex international agreement of this size.

As I had written in The Daily Caller (I also wrote about Basel here at OpenMarket), although the stated purpose of Basel III is -- as it was of its two predecessors -- to "make the international banking system more stable," the accord is instead "likely to dramatically increase the costs of mortgages and small  business loans while making the banking system less stable."

Under the twisted logic of Basel III as written, a U.S. community bank would have to put up two to three times as much capital against a home mortgage or small business loan even to a customer it had dealt with for years. Yet it could buy a teetering European bond with relative ease. And intentionally or not, because of its preference for sovereign debt to count towards bank capital, Basel III would act as a stealth bailout of profligate European governments.

A Wall Street Journal editorial noted recently, "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.’” Yet regardless of the concerns of even its own director, the FDIC as well as the Federal Reserved, had been rushing headlong to implement Basel III.

In addition to questions of public policy merits these regulatory agencies should be looking at, there is also the issue of abuse of authority. To paraphrase an familiar expression about a proverbial duck, Basel III talks like a treaty and walks like a treaty. Yet is has never been ratified by two-thirds of the Senate, as is required for treaties, nor even passed by Congress as some type of trade agreement. In fact, members of Congress from Louisiana Republicans to Maryland Democrats have strongly criticized the accord

The agencies have answered these concerns by saying they are merely treating the accord as a "suggestion." If this is the case, any "suggestions" from Basel III should be subject to the normal (but even then inadequate) procedures of cost-benefit analysis and notice-and comment from the Administrative Procedure Act, and not be "fast-tracked" on U.S. banks as earlier plans would have done.

Basel III has been delayed, and for Main Street growth and financial stability, that is all to the good. But U.S. agencies should follow the U.S. Congress rather than international bureaucrats in deciding whether and how to implement it the next time it is unveiled.