Behind the Scenes – On the way to Basel III

“the most vicious and least public skirmish between banks and their regulators”

What we learned form the recent financial crisis with which impact we are still struggling to gain control over, may be uncertain. But one group of assorted specialists at least are tackling this issue since 2009 and now first resulting agreements on the continuation of the Basel framework have managed into the light and worldwide media.

The essence of an article published in ‘the Economist‘ is broadly summed up about new regulations to boost regulatory capital banks hold to sustain operating losses which is essentially aiming for a reduction of reliance in short-term funding.

– An improvement in quality and quantity of regulatory capital!

Estimated costs of implementation are supposed to be as high as 16% of American banks’ profits and even 37% of European banks’ profits,  according analysts at Barclays Capital and Credit Suisse. Although, in the end the banks accepted the new agreements after they managed to lobby a few compromises and soften the results, they argue the changes will lower economic growth and at all implementation by 2012 won’t meet reality.

The Basel Committee’s states the aim is: “a balanced package where the costs will be phased to avoid economic disruption and the benefits will be substantial.” – meaning the exclusion of low-quality instruments from core capital e.g. preference shares.
As a comparison: up to now a Tier 1 capital required 4% in relation to risk-weighted assets, of which only 2% had to be common stock. No buffer is required. Now, new is the increase of the common equity requirement to 4.5% and a buffer of 2.5% of common equity, protecting the sector from excess credit growth. This totals in a common equity requirement of 7% (>4%), referring to Bloomberg

The banks are allowed to feed on this buffer, yet the closer they get to the minimum requirement, the stricter the limitations on earnings distributions will become e.g. paying dividends and share buybacks.
Especially, Germany’s effort reflects the power of lobbying perfectly and in the end a concession for its state-owned banks has been formulated. Thereby, “Government capital injections will continue to count as common equity until the end of 2017”, which strictly spoken actually would not be approved by the new Basel rules: Yalman Onaran an author bussy at Bloomberg states.

Additionally, capital requirements for systemically important banks are ought to be beyond default. For more details visit Bloomberg.com. Initially though, to build up the required amount of capital will demand selling shares or holding back on returns to shareholders. But lets await 2018 when the regulations will become binding.

One way or the other, these new standards are aiming to force banks to change their business model, Barbara Matthews, managing director of BCM International Regulatory Analytics, concludes.

The FED negated alarms, being convinced that as forecasted capital erosion has not fully materialized, banks eventually will not have to raise that much more capital. Though here is to comment: considering that the definition of capital allowed to be used as reserve has changed and only topping up the pot will thus not be sufficient to meet the requirements, it may not be that easy

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4 Responses to Behind the Scenes – On the way to Basel III

  1. bravenewloock says:

    Here’s a very interestion reaction of Philipp Hildebrand, chairman of the Swiss National Bank, recorded in the Telegraph: “While the reform package is far-reaching, it does not yet comprehensively address the TBTF (“too big to fail”) problem. Further efforts will be required in that area at the international and at the national level.”

  2. vivipre says:

    Thank you for providing this informative post. Here is another interesting article pointing out again the possible negative effects of the new Basel rules: “…reforms will harm global trade and economic growth…”, written in a letter from the Institute of International Finance and the National Foreign Trade Council to the G20 asking for changes to Basel III. Let’s see whether current rules are final and what actual impacts are going to be in 2018.

  3. Very good post, olexa.
    Indeed, Basel III is going to be a central issue for “designing” a safer financial system on a global scale.
    Let us just hope that economies go hand in hand this time (unlike Basel II).

    This time, the starter’s gun has already been in the hand of Switzerland:
    Together with leading executives from the biggest Swiss investment banks UBS and Credit Suisse, the Swiss government has now created even more severe laws than the current Basel III plot.
    Both banks may even need to come up with 19% of risk-weighted capital soon.

  4. Pingback: What’s up in 2011? | BraveNewFinance.

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