The missive from the Swiss city of Basle this weekend outlining the new international regulatory capital framework for banks, now termed Basel III, has apparently provoked a sense of relief from both financial markets and banks. The immediate reaction was that the rules could have been more stringent in terms of capital requirements and the implementation timetable.
The city of Basle is geographically situated on the river Rhine at the meeting point of France, Germany and Switzerland. Partly as a result of this location it has, since early modern history, been the city where international peace treaties and accords have been drafted. In recent history, as a centre of banking, it has been the location for international banking regulators to agree the framework for global banking rules. Will the latest accord to come out of Switzerland's third most populated city result in peace and stability breaking out post financial crisis?
The answer is not clear at this stage. Whilst there is a long journey to travel before the rules are enacted in national jurisdictions, including input from the G20 leaders in Seoul in November, there are a number of fundamental issues which will become apparent in the finalisation of the accord and the implementation in national jurisdictions.
The headlines are that the Basel committee is requiring banks to move from a common equity requirement of currently 2% to 4.5% by 2015. The Tier 1 requirement which includes common equity and strictly defined equity like instruments to increase from 4% to 6% over the same timeframe. The large UK banks, including the two which have been part nationalised, are strongly capitalised above these minimum requirements. In order to maintain and exceed these levels equity will have to be maintained. This may mean restrictions on bonuses, lower distributions to shareholders or raising the cost of borrowing for corporates and individuals.
In addition the concept of a “conservation buffer” of up to 2.5% of capital is being introduced. Essentially this is a tool for regulators to make banks build up reserves in good times to provide a buffer to be released in bad times. The crucial point here is that this will be at the behest of national regulators to dictate when reserves should be built up and released. The opportunity for regulatory arbitrage between national jurisdictions is clear. Balancing strong regulation with international competitiveness will be even more heightened.
Furthermore the liquidity requirements introduced as a supplementary part of the new framework which require more holdings of for instance government debt may have the impact of both lowering returns to banks or potentially creating inadvertent bubbles in sovereign debt.
Basel III may appear on first glance not to be as stringent as expected but as implementation is worked through the practical issues will be challenging on an individual bank, national and international basis. A good starting point; but not the answer to the last financial crisis or eliminating future excess.