Some of the Significant Impacts of Basel III
Much has been made of the increase in the common equity tier 1 ratio from 2% to 7%, mainly that it was less than some policy makers had hoped. However, for business the proposals will be a challenge. While many banks already have ratios above 7% these are based on Basel 2 requirements. The changes mandated by Basel 3 will really add up and even well capitalised banks in Europe and the US could fi nd it demanding. The result could be reduced credit availability or increased cost of credit on the high street.There was unarguably international divergence over implementation of Basel 2, and the same looks inevitable for Basel 3. Those in the West are focusing on the need for increased buffers for both capital and liquidity. Those in the East are focusing on comprehensive coverage of risk management, enhanced stress-testing and the need for risk and capital management to align and be a core part of a fi rm’s strategy. Ultimately, supervisory discretion will infl uence detailed implementation and leave scope for some jurisdictions to apply a more rigid interpretation of Basel 3 than elsewhere. Political issues and debate around implementation and the operation of supervisory colleges mean ongoing fear of an uneven playing fi eld going forward.
There are also as yet no detailed proposals for capital or liquidity for SIFIs. While the FSB has developed general principles, the French presidency will help to defi ne how these will operate in practice, and different jurisdictions are likely to adopt the rules inconsistently for domestic SIFIs, further adding to possible divergence.
A phased in timeline has been agreed by the BCBS, but in some markets there is a trend, spurred on by regulators and market analysts, for some banks to set ambitious compliance deadlines. For banks, they see early implementation as a competitive advantage, a way of demonstrating their soundness. Other organisations should be aware of the reputational and regulatory risks of being perceived as trailing behind in the race to compliance - and respond accordingly.
Much focus has been on the impact on profi tability. With common equity requirements more than tripling, estimates of eligible capital reducing by up to as much as 60%, and estimates of risk weighted assets (RWA) increasing by up to 200% or more depending on a firm’s circumstances, it seems likely that there will be an impact on return on equity (ROE), the level of which will depend on individual operating models.
Yet, the proposed rules will go far deeper than a simple impact on profitability and ROE. The requirements will have a fundamental impact on business models and the shape of the business done by banks. Some commentators fear – and others welcome – the potential to return to a regime similar to the one that operated a century ago, in which there was limited competition, much less maturity transformation and much less innovation in fi nancial services.
Alongside the proposals for increased regulation in the area of capital and liquidity, is a debate around the degree of intensity of supervision that supervisors apply to institutions. Enhanced supervisory practices will be a major focus of the Basel Committee in 2011. Whether individual countries prioritise the squeezing of firms’ business models to drive structural change, or ramp up their supervisory efforts, will have a huge impact on individual fi nancial institutions.
Amongst all of the debate on the new proposals, it is worth noting that the fundamental approach introduced by Basel 2 for determining credit risk weighted assets through internal models has not changed. As with Basel 2, Basel 3 remains a ‘risk based’ capital regime. Banks should therefore keep in mind that regulators will continue to focus on risk management and governance in underpinning a robust fi nancial sector. Those which do not are likely to fi nd themselves subject to even greater requirements and scrutiny.
Successful implementation and response must start early, and many institutions have already begun this process in light of the framework now agreed.
Basel 3 is sometimes sold as the solution to the outstanding issues left by Basel 1 and 2. While history doesn’t repeat, it sure does show similarities, and it is very unlikely that Basel 3 will be the answer to all the problems. Institutions must therefore retain flexibility to accommodate years of fi ne tuning and future reforms.
Dissertation Writing Help on Basel III- Issues and Implications
Changes to capital levels, capital definitions, and risk asset levels will lower returns
– Impacts asset/financing businesses including trade finance and corporate lending, with greater relative effect on certain banks (e.g. G-SIBs), products (e.g. Export Credit Agency), regions (e.g. Emerging Markets financing), and corporate segments (e.g. non-IG/SME companies)
– Total leverage ratio may become a binding constraint at times on both asset/financing growth and deposit growth New Asset Value Correlation Multiplier (AVC) and new leverage ratio will negatively impact L/C advising and confirmation
– Especially affects trade flows with Emerging Markets
New liquidity and leverage ratios will redefine banks‟ balance sheet appetites
– Certain types of operating services businesses will be preferred, e.g. operating deposits from corporate cash management.
May impact appetite for off-balance sheet commitments, e.g. Standby L/Cs Risk distribution strategies will grow in prominence
– Banks will migrate more towards becoming intermediaries between corporates & investors, rather than being book & hold Industry consolidation is likely to grow
– Operating scale and efficiency, and access to deposit funding (both currency and locale) will favor some banks, driving others to reinvest limited capital elsewhere. Banks without access to USD funding will struggle for survival in Trade Finance
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