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The Basel Consequence Many Aren't Considering (December 20, 2007)

Location: New York
Author: Lenny Broytman
Date: Thursday, December 20, 2007

For years, off-balance sheet transactions and lackadaisical investment strategies have allowed banks worldwide to operate with an extremely limited amount of liquid capital on reserve and the new Basel regulations have been taking key steps to remedy all of that.

The desired results would fix years of carefree investing within the investment banking sector and would create some stability and regularity but could the effects also be negative? According to, that is exactly what Ernst & Young Item Club's Peter Spencer thinks. For Spencer, fully implementing the Basel capital requirements could ultimately prove to be "disastrous" for London's money markets.

It is important to point out that banks themselves are at risk. In doing their best to comply with these new requirements, lending will decrease as well as the money they lend to one another. With a global credit crunch in full swing, Spencer really just does not see this ending well for anybody.

"If these funding routes are not reopened it will have massive consequences for the economy as a whole," he said. "It will make 1929 look like a walk in the park."

When just last week, central banks worldwide announced that they were going to be injecting funds into their money markets in an effort to increase the kind of collateral they'd get in return, Spencer simply dismissed the action as "window dressing".

"This won't get to the core of the problem: the fundamental lack of collateral. As these problems drag on, the consequences for the macro-economy of not relaxing [the Basel regulations] are unthinkable."

Not only will lending amongst banks be stifled, consumer lending will take a large hit as well if banks become increasingly consumed with maintaining the proper capital minimums on hand.

The comments from Spencer come just as Bank of England markets expert Paul Tucker noted that the aforementioned Basel regulations were one of the primary ways he fought off the pending credit crunch. Spencer noted that although the newest batch of Basel guidelines will make the situation somewhat better, the issue at large will still remain a big problem within the banking sector.

"The Bank is staring into the abyss," he said. "The Financial Services Authority must go round and check that all banks are solvent, and then it should cut the Basel capital requirement level from 8pc to about 6pc.

"Until then, with the money markets frozen, the Bank will have to go on being the lender of first resort, rather than of last resort."

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