Stabilizing Banks in the Eurozone: the Basel Committee as Arbiter on Sovereign Risk Weights

The Basel Committee on Banking Supervision is due to finalise recommendations on risk weights for sovereign exposures in its 2017-2018 work program. Behind this technical announcement is a conflict over whether bank regulators should treat national treasury bills as if they had zero risk of default. This has implications banks worldwide, since holding state debt as safe assets is a standard and necessary practice of portfolio- and therefore risk management. And yet successive international financial crises, including the Eurozone crisis, have demonstrated that sovereign debt is risky. In Europe, conflicts between North and South over the establishment of a European Deposit Insurance System with a mutualized Deposit Insurance Fund—itself the last missing piece of the puzzle to create Banking Union and stabilize the Eurozone, began to revolve around the question of whether to officially end the treatment of sovereign debt as risk-free. Germany, the Netherlands and influential players within the European Parliament demanded that the issue be sorted out, and sovereign debt holdings by banks be correspondingly reduced before talks over mutual insurance could begin. France, Italy, and much of Southern Europe defended the status quo. The European Commission sought compromise, but close to the German position, and both the European Central Bank and European Systemic Risk Board proposed innovations based on creating synthetic European Safe Assets based on mixtures of safe, risky and mezzanine debt. In other words, the EU is looking at re-launching securitization as a means of getting out of the negative feedback loop between states and sovereigns that has plagued the Eurozone since 2010. This paper demonstrates that the European Union, as it often does, is delegating arbitration of a conflict between member states over an intractable issue to an international standard-setting body. In the past, it has done this for accounting standards (delegating to the International Accounting Standards Board), for securities directives (to the International Organisation of Securities Commisssions), for insurance directives (to the International Association of Insurance Supervisors), and in Banking Union, to the Basel Committee on Banking Supervision. While Basel Committee standards have been used before to set some of Europe’s bank capital standards (for Global Systemically Important Institutions, but not smaller ones), and while Europe is unable to accept delegation to Basel to defuse conflicts with the United States over the relationship between borrowing and the riskiness of assets, it does use the Basel Committee as an arbiter for an important part of Banking Union. This paper examines why the EU has agreed to use the Basel Committee for that purpose in this instance, and what makes it special.