Why Basel III needs to be overhauled: Strategist

Federal Reserve Chair Jerome Powell's Thursday testimony focused in part on the Basel III capital rules, which banking institutions have pushed back on, citing costs and economic impacts. In response, Powell signaled the rules would undergo a broad overhaul.

Chris Whalen, Chairman of Whalen Global Advisers, joins Yahoo Finance to discuss what changes to expect to Basel III.

Whalen highlights the flaw in Basel's design: "Basel is a very old construct. It was focused on credit risk originally, if you go back to the beginnings. And over time [the Fed] has tried to expand it to try and cover other kinds of risk. And I think the industry and many others have said, look, you're double counting. You're covering this and you're covering that, and you're really doing the same thing twice. So I'm hoping they're going to rationalize things a little bit and make things simpler."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Nicholas Jacobino

Video transcript

JOSH LIPTON: Jerome Powell facing questions on Capitol Hill this week on the Basel III capital rules, which he says will undergo a broad overhaul. Banks have pushed back on the rules saying they are too costly and would have an economic impact. Joining us now to talk about all this, Chris Whalen, Whalen Global Advisors Chairman.

Chris, it is always good to see you. So this did, you know, got some attention, Chris, here. Powell saying that, yes, central bank would be maybe making some meaningful changes here, Chris. What did you-- what did you make of that? And what changes would you expect?

CHRIS WHELAN: Well, the entire mortgage complex pushed back pretty hard on Basel. And I think even Powell said that he was a little bit taken aback by the level of opposition from a broad range of constituencies. It wasn't just the banking industry. You had the mortgage bankers, the realtors, the homebuilders, really the whole community.

So I think that is going to probably force him to repropose the entire [INAUDIBLE]. I expect them to be nicer to mortgages. But there are some themes that aren't going to change. I think they're very concerned about structured finance. They want to increase capital cover for those sorts of transactions, especially banks buying them for portfolio. And I do think they are going to try and tweak some of the other areas, market risk, obviously, Silicon Valley Bank.

But basically, Basel is a very old construct that was focused on credit risk originally if you go back to the beginnings. And over time they tried to expand it to cover other types of risk. And I think the industry and many others said, look, you're double counting. You're covering this and you're covering that, and you're really doing the same thing twice. So I'm hoping they're going to try and rationalize this a little bit and make it simpler, because it's a modeler for banks. Simple is better. If I want to understand a bank, I want the relationships I look at to be as clear and as simple as possible.

JULIE HYMAN: Chris, you may have seen, there was one person today who was not happy about the comments that Jay Powell was making. And that was Elizabeth Warren. I want to play for you what she had to say.

CHRIS WHELAN: Oh, good.

ELIZABETH WARREN: You are the leader of the Fed. And when the heat was on last year, you talked a lot about getting tougher on the banks. But now the giant banks are unhappy about that. And you've gone weak-kneed on this. The American people need a leader at the Fed who has the courage to stand up to these banks and protect our financial system.

JULIE HYMAN: That was a great soundbite, wasn't it, Chris? You've gone weak-kneed on this, says Elizabeth Warren. I mean, it does feel like a victory for the banking lobby certainly if they're pulling back on this. But you seemed to indicate that it didn't necessarily make sense in the first place.

CHRIS WHELAN: No. The whole construct of Basel is kind of old. We need to rebalance it. I'll give you an example, Julie. I have a model that my partner, Dennis Santiago, and I built 20 years ago that the SEC still uses. And we're going to propose to them that we rebuild it, because, periodically, you have to go look at these things. Things change. The economy changes.

I think Elizabeth Warren's comments are just dramatic. She doesn't really understand banking. She pretends to. And a lot of the things she says she knows are wrong. But she says them anyway, because it plays to her constituency and the progressive movement.

Banks have been turned into commodities, they're utilities now. And the only reason our economy is still functions as well as it does is because we have a private bond market, we have private non-bank financial companies. And that's where the innovation is.

Look at JPMorgan, it's only half bank. The other half is Wall Street. So if you're looking for economic growth, job creation, that sort of thing from banks, no. And remember, Elizabeth wanted us to drop interest rates to boost homeownership, just the opposite will happen now, because there's such a tight market for homes. If you drop interest rates today, home prices would soar. You would see home prices for the bottom half of homes go up double digits next year. So don't do that, you know.

It's been great for credit. There's been no defaults in residential mortgages for years. But we have to realize that there's a lot of inflation in the system. And it's going to be very hard to deal with that. And it's sad because people need homes. They need a place to live.