Last year we discussed how Basel II is crippling trade finance, but it looks like the worst might be yet to come. According to some reviewers, Basel III, the forthcoming update to the Basel Accords, might stifle it.
As per this recent article in the Financial Times, the top 35 banks will face a $100 Billion Basel III shortfall in equity capital after the new regulations are imposed, with 90% of the shortfall concentrated in the biggest six banks. Barclays Capital estimates that the banks will need to hold top-quality capital equal to 8% of their total assets.
Not only will the Basel III reforms force banks to increase the risk adjustment for big swathes of their business, but it will gradually tighten the definition of what counts as tier one capital, putting many of the US banks who are already on shaky ground on top of a fault line. This could force banks to curb lending to the real economy or raise borrowing costs.
Plus, as described in this post over on the Reuters blogs, when credit in an economy is growing faster than the economy itself, a countercyclical capital buffer kicks in, which essentially says that banks need to have more capital in good times. So, instead of the 7% common equity, 8.5% Tier 1 capital, and 10.5% Tier 2 capital, the banks will need 9.5% common equity, 11% Tier 1 capital, and 13% Tier 2 capital.
And that’s just the beginning. In 2015, the liquidity coverage ratio gets introduced and then the net stable funding ratio arrives in 2018. And the committee is reviewing the need for additional capital, liquidity, or other supervisory measures to reduce the externalities created by systemically important institutions.
While stronger measures are obviously needed, as the economy cannot afford another Bear Stearns, if it’s too much, too fast, will the banks be able to handle it?