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Leading the opposition to the Basel Committee on Banking Supervision’s proposals are the French, who fear that they will lead to an increase in banks’ capital requirements.
The US has a market-based financial system and continental Europe has a bank-based one. Non-financial groups’ bank loans make up 14 per cent of gross domestic product in the US while in the eurozone it is 89 per cent. It follows that the unintended consequences of regulation have a bigger impact in Europe than they do in the US.
Why are the French so opposed to the Basel Committee’s plan to set the output floor at 72.5 per cent of a bank’s risk-weighted assets? For a start, four of Europe’s 10 biggest banks are French. But that is only part of the story.
One of the implications of having less developed financial markets, and fewer securitised assets, is that European banks do not “originate and distribute” their customers’ loans. A post-crisis objective of international regulators was to reduce the dependency on banks for financing and increase the role of capital markets in Europe. This has happened to some extent, but household loans, mainly mortgage loans, remain on European banks’ balance sheet, whereas US banks securitise most of their loans.
Are banks’ mortgage risks the same in Europe and the US? This question is key. If the risks are not the same, then the standardised approach to international regulation could lead to capital requirements being under-estimated, which is a criticism often levelled at banks’ internal models.
The main driver of US banks’ lending decisions is the pro-cyclical loan-to-value ratio. However, French banks use the more stringent debt service coverage ratio as the key criterion of a borrower’s ability to pay. Moreover, the household mortgages offered by European banks (with the notable exception of Spain) have fixed rates, which reduce the risk of default.
We should also bear in mind that regulators validate the internal models used by banks. In the past, the Basel Committee considered that the use of internal models allowed banks to manage their risks better. Under the Basel II rules implemented before the crisis, such models were the norm.
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