Basel III - Will Basel III be a Needle-Mover?

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Will Basel III be a Needle-Mover?

September 09, 2010

With aftershocks of the recession still reverberating and a very real double-dip threat on the horizon, regulatory officials from more than two dozen countries have come up with a new set of capital standards known as Basel III for the global banking community on Tuesday. The convention is to adopt tougher measures, helping prevent a recurrence of global financial crises and restoring public confidence.

The formal approval of the Basel III proposal is expected on September 12, 2010. The entry point of capital requirements will be different until the introductory period ends in 2018. Will this be perilous to the U.S. banks, or is this what the doctor ordered?

The Basel norms focus on regulatory capital requirements that the banks should maintain. Though the average U.S. banks may fall short of these criteria in the near term with lower capital levels following the recession, they have been raising billions of dollars through the issuance of equity and trying to deploy capital much more cautiously than before. However, major large-cap U.S. banks appear to comfortably maintain the extra capital norms that the Basel Committee advocates.

So what does Basel III mandate? And how comfortable will the U.S. banks be? Here’s a quick look:

Tier 1 Capital Requirements

Banks will have to maintain a minimum Tier 1 capital ratio as high as 12.0%. This will comprise a minimum buffer of 6.0%, a conservation buffer of 3.0% and an additional 3.0% anti-cyclical buffer. The anti-cyclical buffer will help increase the Tier 1 capital requirements to 12% during boom times.

Do U.S. banks comply? As of June 30, 2010, the major banks in the country maintained Tier 1 capital ratios above the proposed minimum level. Bank of America (BAC - Analyst Report), JPMorgan Chase & Co. (JPM - Analyst Report), Wells Fargo (WFC - Analyst Report) and Citigroup (C - Analyst Report) had Tier 1 capital ratios of 10.7%, 12.1%, 10.5% and 12.0%, respectively. The capital ratios are expected to somewhat reduce following the repayment of bailout money by some banks. Still, the Tier 1 capital ratios of these banks are not expected to fall below the new minimum capital level requirement.

Tier 1 Common Capital/Core Capital Requirements

The Tier 1 common capital ratio requirement would increase to a minimum of 5.0% along with a conservation buffer of 2.5%. Also, there will be an additional anti-cyclical buffer of 2.5%.

The major U.S. banks swim through these requirements as well. As of June 30, 2010, Bank of America, JPMorgan Chase, Wells Fargo and Citigroup had Tier 1 common capital ratios of 8.0%, 9.6%, 7.6% and 9.7%, respectively. Like Tier 1 capital ratios, the most shock-absorbent Tier 1 common capital ratios are also not expected to decrease below the minimum required level following the repayment of government money by most of the relevant U.S. banks.

Will Dividend Growth be Challenged?

According to the proposals under Basel III, only if a bank operating in a steady economic environment maintains a Tier 1 capital ratio of 12% would it be allowed to pay or increase common dividends. As a result, the pace of dividend increase could be slow as banks will first use earnings to meet the additional capital requirements. However, if the banks can fulfill other regulatory requirements, the dividend increase would follow in due course. Increasing profitability may also help increase dividends.

Though some of the major banks with strong capital ratios would have been able to increase dividends if the proposed capital requirements were immediately implemented, banks with weak capital ratios, including U.S. Bancorp (USB - Analyst Report), would have to avoid paying dividends.

Financial Reform Law, the Basel III Harbinger?

The recently passed U.S. financial reform law has already rung in what Basel III is contemplating. Tighter regulations of the recently enacted financial reform law for companies that had threatened the economy are in place. The sweeping financial reform law also imposes stricter capital requirements on banks.

This law would partially restrict the proprietary trading of commercial banks. Also, derivatives trading, used to hedge risks or speculate the future value of assets, would be restricted. Banks will be banned from proprietary trading and will be able to invest only up to 3% of their Tier 1 capital in private equity and hedge funds.

Conclusion

The economic benefits of standards like Basel III are indisputable, as these would somewhat reconstruct the weak capital level that threaten the economy. The norms could ultimately translate to fewer bank failures and less involvement of taxpayers’ money for bailing out troubled financial institutions. However, with the financial reforms already in action, the Basel III would be akin to preaching to the converted. The new standards will probably not be able to add to the nation’s gains.

Regulators and bankers are bound to disagree over the magnitude of positive impact of the new rules as there remain other lingering concerns, including the high unemployment rate, continuation of residential and commercial real estate loan defaults and liquidity challenges. However, over a longer period of time, small U.S. banks, which run with lower capital ratios, will be forced to maintain required capital standards, providing buoyancy to the economy.

On the other hand, the double bind of the Basel III capital standards along with the financial reform law will compel the financial system to go through a massive de-leveraging, and banks in particular will have lower leverage. The implication for banks is that the profitability metrics (like returns on equity and return on assets) will be lower than in recent years.

Above all, the lower leverage due to these restrictions will be a throwback in a sense, leaving banks to perform only their basic functions, including lending and taking deposits. Would Basel III end up curbing the socio-economic functions of banks and de-weave the financial fabric?

www.zacks.com/stock/news/39953/Will+Basel+III+be+a+Needle-Mover%3F

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Fears for German banks under new rules
Published: September 9 2010 21:04 | Last updated: September 9 2010 21:04

A member of the European Central Bank executive board has warned that some of Germany’s most important banks are undercapitalised, increasing fears about the consequences for the country of impending global standards that will impose even tighter capital requirements.

The comments by Jürgen Stark come days before global regulators are set to agree a reformed set of capital standards known as Basel III. They will demand that banks hold much more capital to arm themselves against any repeat of the global financial crisis.

Germany is seen as one of the countries most vulnerable to the effect of any Basel reforms. Historically low on capital, many of the country’s banks have also relied proportionately more on types of hybrid equity that may now not meet Basel requirements.

Martin Blessing, chief executive of Commerzbank, said at a banking conference on Thursday, organised by the Handelsblatt newspaper, that about half of the German banking system also had no access to capital markets to raise equity. This is because many banks’ public or mutual ownership structures exclude the possibility of outside investors.

Germany’s association of public sector banks warned on Wednesday that €50bn ($63.5bn) of so-called silent participations – a hybrid form of capital often used by German banks – could be “regulated away” if they were no longer permitted to count towards core capital.

“The tightening of capital rules is directed against the German banking system,” the association said, adding that Germany should be prepared to veto an agreement this weekend.

It followed a warning from private sector banks that Germany’s 10 largest banks – a mix of private, public sector and mutual institutions – could be short of €105bn of capital.

Germany’s 430 locally controlled savings banks – which Mr Stark has suggested be opened to private capital following similar initiatives in Italy and Spain – have also predicted that they would have to reduce lending by up to one-third under one scenario of tighter Basel rules.

“This cannot seriously be what regulators and politicians want,” Heinrich Haasis, the head of the savings banks’ association, told the banking conference.

German banks’ frantic lobbying and predictions of economic shock – based so far on worst-case expectations of what Basel might deliver – have only partly been acknowledged by regulators who are concerned to strengthen the global financial system against shocks.

Axel Weber, president of the Bundesbank, has said he expects new rules to be agreed and that “different national interests will not block the reform process”. He also dismissed fears that Germany’s powerful export-led economy could be damaged by banks having to cut back on lending to preserve their capital.

But German regulators have also pleaded with international counterparts for the special case that their country’s banking system – heavy with tiny public sector and mutual lenders – represents.

In spite of the pressures to come from Basel III and the warning from Mr Stark, German banks are not in immediate danger of falling short of regulatory capital requirements.

All but one, Hypo Real Estate, passed the recent EU stress tests.

A key demand of German banks, politicians and regulators is therefore that the Basel process allows a lengthy implementation period – perhaps 10 to 15 years – to allow higher capital requirements to be fulfilled more easily through retained earnings.

By contrast, UK and US regulators want a much speedier transition.

www.ft.com/cms/s/0/63677394-bc35-11df-8c02-00144feab49a.html

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A V Rajwade: A new G20 agenda?

September 20, 2010, 0:17 IST

As preparations for the next G20 summit (Seoul, November) gather momentum, there has been some progress since the last summit — the Basel Committee on Banking Supervision constituted by the Bank for International Settlements has agreed on new norms for banks’ capital adequacy standards (Basel III). These norms prescribe a significant increase in shareholders’ funds, and have also increased the capital charge for market risk. The US has enacted tighter and highly complex banking regulations, and the European Union (EU) is also well on its way to finalising financial reforms later this year. Neither of these may achieve the full extent of the reforms envisaged by the G20, but very strong and powerful bank lobbies have been working hard, in Basel, Brussels, London and Washington, to dilute the prescriptions (more on the new regulations in a later article).

There is also the question of whether the cost of new capital ratios and other regulations will be passed on to and borne entirely by the banks’ customers — higher lending rates, for example, would, over the long term, affect global growth. One major unresolved issue is the convergence of accounting standards prescribed by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB): this is unlikely to be achieved in the current year, as originally targeted.

On the other hand, major problems and contradictions in the global economy are coming to the fore. Many conventional correlations seem to be breaking down. For example, loose monetary and fiscal policies are supposed to be inflationary. There is no sign of this in the US, Europe and Japan. Again, gold is supposed to be an inflation hedge and conventional wisdom suggests that its price would go up in anticipation of high inflation. The gold price has been setting new records, but the yields on inflation-adjusted bonds in the US, for example, show few signs of inflation rising.

The other major disconnect is that the substantial fiscal and monetary stimuli have, broadly speaking, failed to trigger sustained economic growth: to be sure, some economists, Paul Krugman for example, had predicted that, in the US the fiscal stimulus would prove to be inadequate. In the recently published Annual Outlook for 2011, the United Nations Conference on Trade and Development (UNCTAD) apprehends a contraction in the world economy in 2011, and worries that an exit from stimulus-driven macro-economic policies in the developed countries may lead to a “deflationary spiral”. To be sure, some members of the G20, China and India for example, seem to have been broadly unaffected by the diseases of the developed world.

Ominously, global imbalances (a code word for Chinese surpluses) have started widening again. As the yuan appreciation continues at a snail’s pace, China’s surplus is a potential danger to global economic co-operation. As trade tensions rise, a Bill providing for punitive tariffs on Chinese imports is making its way through the US Congress; the EU has also warned against increased tariffs on the import of car wheel rims from China. Given China’s status as the world’s largest market for light vehicles (China 15.6 million, Japan 9.1 million and the US 7.1 million — 2010 estimates), its capacity to retaliate should not be underestimated. The EU, for example, exported auto parts worth $5 billion to China last year, besides a large number of cars.

In the US, unemployment stubbornly remains close to double digits, even as the number of those classified as being in “involuntary part-time” working, continues to rise, the latest number being 9 million. And, Japan, now the third largest economy in the world, continues to experience stagflation (“flation” preceded by “de”, not “in”) exacerbated by an appreciating yen. After six years, Japan intervened in the exchange market last week when the currency fell below ¥83 to a dollar; it is also blaming China for fuelling yen appreciation through its purchases of yen bonds for its reserves. Though the yen is back above 85 post-intervention, its longer-term success is questionable since the continued appreciation of the Swiss franc, despite sizeable intervention, shows that it has fallen below parity against the dollar. (Another interesting contradiction is Switzerland, along with Germany, the fastest growing economy in Europe.)

The growth picture in the EU is getting more confusing. The European Commission has recently revised its earlier forecast for growth in the current year, from 0.9 per cent to 1.7 per cent (eurozone) and 1.8 per cent for the EU as a whole. On the other hand, latest data suggest stagnation in factory output in the eurozone. And, the reputed ZEW economic research institute recently reported a sharp fall in its index of expectations for the economy; the index has now plunged into negative territory.

Finally, President Obama may find himself on a weak political wicket by the time the G20 summit begins as poll after poll suggest a sharp setback to his Democratic Party in the mid-term elections later this year — in the US, the conservative right is making a strong comeback.


www.business-standard.com/india/news/a-v-rajwadenew-g20-agenda/408544/

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What are central bankers for?


19 September 2010 -

The weekend before last central bank governors and financial regulators agreed the new Basle III rules for commercial banking. The core of the new rules comprises a substantially increased common equity requirement for banks on their loans and investments. The timing however does a big favour to banks giving them until 2015 to achieve the new threshold, while in an equally positive decision for all financial institutions, governors and regulators postponed for the end of next year any new measures on derivatives.

In more details now the governors and regulators package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. This reinforces the stronger definition of capital agreed by governors and heads of supervision in July and the higher capital requirements for trading, derivative and securitization activities to be introduced at the end of 2011.

According to a press release by the Bank for International Settlements “these capital reforms, together with the introduction of a global liquidity standard, deliver on the core of the global financial reform agenda and will be presented to the Seoul G20 Leaders summit in November.
Despite the fact that the increase of the capital requirements at 7% from 2% seem very important, the Basle III rules remain below what the UK, the US and Switzerland have already raised to 10%. So in the face of it the new decision adds nothing to what we already knew from many months. The increased common equity requirement though may present grave problems to banks that have no or limited access to capital markets.

In any case all and every bank with low common equity capital will be forced either to increase it or decrease the amount of loans and investments.
This means that a good number of banking institutions will be competing over the coming months and years in the capital markets by trying to place fresh issues of stocks. Those lenders that have not already completed or have not announced yet new share sales are going to face after some time an increasingly difficult capital market, having to answer questions about the reasons why they have not already set up plans for new capital. Everybody knew that Basle III was coming. Over the next months and years western capital markets will be very interesting to watch. At this point it has to be noted that Deutsche Bank announced last week that is going to tap the market for 9.8 billion euro in new equity, mainly to facilitate its acquisition of the Postbank. Deutsche Bank’s CEO Josef Ackermann however said in a statement that the new equity issue is also aimed at “strengthening the bank's capital in the light of expected regulatory changes." It is not a surprise that many European banks will need more common equity capital. The most precautious of them are ahead of time.

In any case all those things are not to happen overnight. Governors and regulators provided much time for banks to adapt. Under the agreements about equity capital increase will be phased in by 1 January 2015. The Tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6% over the same period. The time to adopt given to banks is being considered by capital markets as more than enough and that is why stock exchanges held parties this past week. As for the issue of applying stricter rules in derivative and securitization activities, central bank governors by postponing this proved once more that they are there for the shake of banks and not for the wider economy not to say the democratically institutionalized society.

www.neurope.eu/articles/102686.php