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Bank business models and the Basel system
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The Basel Committee on Banking Supervision (BCBS) has continued to lead the process
of bank micro-prudential reform since the global financial crisis in 2008-09, evolving a set of
proposals collectively referred to as Basel III.1 The latter is a vast improvement over Basel II,
which created an across-the-board cut in capital for banks prior to the largest crisis since the
1930s. The BCBS proceeded to revise Basel II by adding on to it a vast set of complex new
rules.The primary focus of the BCBS is on capital rules applied to risk-weighted assets; it has
not been charged with examining the structural business models of banks to which these
capital rules apply. By necessity the process has been one of policy “on the run”, which was
not able to benefit from any evidence-based research.As more and more data on banks since
the crisis comes to hand this situation is changing, and the relative importance of business
model factors and capital and liquidity rules in influencing the riskiness of banks can be
tested. This paper reviews the Basel III proposals, presents new evidence about the factors
determining the riskiness of banks, and asks whether structural reform of banks business
models is a necessary part of the reform process.
There are two broad paths to bank failure: fundamental insolvency and/or liquidity
crises typically arising from counterparty risk. A sudden decline in asset values (if properly
marked to market) can wipe out bank capital. But the very risk of this in a crisis makes
counterparties unwilling to lend, which is especially problematic when banks need cash
and/or liquid securities to meet margin calls for derivatives transactions, repos and other
collateral needs.2 This depends very much on the structural business model of banks. Bad
assets, on the other hand, are easier to hide, particularly when they are illiquid, rely on
mark-to-model valuations and/or are held to maturity in banking books.3 These assets
may take many years to mature, at which time their true recovery value is realised