Third time's the charm?

By N.M. | NEW YORK

GIVEN the global nature of banking, there really was no alternative to relying on the Bank for International Settlements as the primary regulatory body addressing the problem of over-leverage. And the agreement announced yesterday does indeed address an important part of the problem, specifically the use of preferred stock and more exotic debt-equity hybrids to boost "Tier 1" bank capital. Going forward, banks are going to be obliged to maintain a much healthier amount of true common equity. Simplicity and transparency on how much equity banks actually have is welcome.

But the instant enthusiasm for the agreement does seem a bit overdone. Most obviously, talking about a new regulatory scheme reducing bank profitability reflects a fundamental misunderstanding of how a competitive economy works. Profit goes to zero in situations of perfect competition. Regulation, by erecting barriers to entry, reduces competition. Those banks who are able to meet the regulatory requirements should be even more profitable than before because of lower competition. Of course, the banking sector as a whole might be less profitable under Basel III than it was before, but only if less capital in aggregate was allocated to the banking sector. Individual banks will still need to attract investors—more common-equity investors than ever, in fact—and those investors will demand a competitive rate of return. No bank regulation can change that.