Basel rules force small countries to face irrelevant risks – Bahamas governor

Banking regulations set by international bodies are forcing the regulators of smaller countries to ignore some of the biggest risks they face, according to the governor of the Central Bank of the Bahamas.

Small countries often have “difficulty interfacing” with international financial rule-making bodies because they are not set up to do so, John Rolle said on October 30.

He made his remarks in a strongly worded speech to representatives from the Basel Committee on Banking Supervision (BCBS), the Financial Stability Institute and the Bank for International Settlements.

Rolle said these organisations should “explicitly” consider small countries when developing new regulations and help them to maintain these rules.

The organisation’s evaluation process should also give small countries “a fair chance to demonstrate compliance in the context of each country’s economy and society”, he added.

However, Rolle said the reality was starkly different. Despite international financial rule-making bodies “generally” expressing goodwill, most “lack comprehensive policies in the above areas”.

“Few… are set up to disadvantage small countries, but several of them can bruise us inadvertently, and we would like to see international practice improve to reduce this bruising,” he said.

Conceding to small-country concerns is often a question of quantifying and recognising the unintended or spillover consequences of international standards

John Rolle, Central Bank of the Bahamas

The crux of the issue rests on the fact that these institutions are often tasked with creating rules around outcomes that are globally systemic; outcomes small countries are “less likely” to experience.

“Conceding to small-country concerns is often a question of quantifying and recognising the unintended or spillover consequences of international standards, and determining how or sometimes whether to act to offset adverse externalities,” the governor said.

Basel in the spotlight

Rolle said the BCBS needs to consider the impact it has on smaller countries’ banking systems.  

“I certainly don’t suggest that you [BCBS] move away from making rules for internationally active banks, but please try to remember – ideally, not just around the margins – that a great many non-member countries will strive to adopt the Basel rules, both for international and domestic banks,” he said.

Stress tests are a key example of regulations that could harm the financial systems of smaller countries, Rolle said.

“North American and European banks are spending billions of dollars a year on financial stress testing. That is their business. It should not be our business,” the governor said.

The Bahamian banking system has a Common Equity Tier 1 (CET1) ratio exceeding 30%, according to data from the central bank.

Ignoring risk

Rolle argued that small countries would be better advised to base local banks’ capital ratios around risks that are more relevant to their own jurisdictions. In the Bahamas, this could include the economic impact of a hurricane.

“Most hurricanes which hit the Bahamas have not presented a financial system threat. But a Category 4 or 5 hurricane passing to the close north of this island could hurt us very badly. How badly? We don’t know. Why don’t we know?… because the relevant staff are working on financial stress tests that, in all honesty, are more for Financial Sector Assessment Program consumption than our own use,” he stressed.

International rules around the resolution of domestic systemically important banks (D-Sibs) are also proving difficult for small countries.

“We have a minimal equity and nearly no-debt capital market, and deposits handily fund loans. So why would we do total loss absorption capacity?” the governor asked.

In common with most small countries, the Bahamas would not be able to “afford” to close a D-Sib and there are no capital market providers to bear the failure risk.

“Why are we putting a lot of time into internal capital adequacy assessment processes, recovery plans, resolution plans, and the like? Because that is the international expectation,” he said.

Instead, the governor recommended that smaller countries be given the freedom to develop “super-simplified but pragmatic” approaches to the problems they face, which would minimise but not “eliminate” the option of a public-sector bailout.