Earlier this month, the G20 approved Basel III, which, among other things, set new requirements on bank capital in an effort to prevent a repetition of the 2008 crash. However, because Basel III had to secure the support of such a diverse group, it gravitates to the lowest common denominator. Although Basel III is mulling asking systemically important banks to hold more, the minimum ratio of top quality capital to risk-weighted assets it recommends is seven per cent, below the 11 per cent that Lehman Brothers reported a fortnight before bankruptcy. This will be brought in over nine years, while rules on liquidity will only start being implemented in 2015. One of the greatest weaknesses of Basel III is that it still relies on credit ratings agencies for risk weightings, even though they were badly caught out by the crisis. Basel III also perpetuates the fallacy that some assets are risk-free, requiring nothing or next-to-nothing to be set against them. The essence of the last crisis was that assets that were believed to be risk-free blew out in unforeseeable ways. The danger that concealed risk will be able to accumulate therefore remains, especially as Basel does not apply to non-deposit-taking financial institutions such as money market funds and investment banks. These often act like banks and can pose considerable systemic risk. An international commission is going to look into that next year, but the Basel experience does not engender optimism.

Swiss regulators have recognised some of these weaknesses and will set higher standards and a faster timetable for their largest banks, a practice known as ‘super-equivalence’. UBS and Credit Suisse will be required to have a capital ratio of 19 per cent by 2013. Like Switzerland, the UK has a concentration of very large, systemically important banks with balance sheets bigger than GDP. It should follow the Swiss example.

There is some support for super-equivalence in UK regulatory and government circles. Bank of England governor Mervyn King has been the most forthright in his criticism of Basel III, judging it ‘insufficient to prevent another crisis’. Meanwhile, FSA chair Adair Turner and financial secretary to the Treasury Mark Hoban have both insisted that the UK has the right to go beyond Basel.

This may seem encouraging, but a pattern is emerging of robust words on banking reform being followed by backsliding. The FSA has reversed its 2009 decision to impose tough new liquidity rules, deciding to wait for the Basel rules instead. Chancellor George Osborne wants to drop planned disclosure rules on the details of bonuses paid out by banks in the UK in favour of upcoming European legislation, which is widely expected to be softer. Any action on super-equivalence will have to wait for the Independent Commission on Banking to report back in September 2011.

Instead of colluding in kicking this into the long grass, Labour should make this issue its own. Doing so would also help draw a line under the way in which Labour in government conflated too readily the commercial interests of British banks with the long-term interests of the nation. International minimum standards of regulation are essential but the idea that national regulators cannot move one millimetre beyond without securing global unanimity first is both a recipe for paralysis and a surrender of national autonomy on a jaw-dropping scale.

I have long abandoned hope that Labour will advocate a structural overhaul of the UK banking sector. Super-equivalence, the next best thing, still offers plenty of scope for Labour to be relevant and constructive. It also has the potential to drive a wedge not just between the coalition partners but also (and more importantly) between George Osborne and the Bank of England.

Photo: Patrik Tschudin