Despite uncertainty around Basel III – specifically whether banks will have enough capital, and issues regarding their risk and exposure, the legislation doesn’t seem to be as onerous for banks as once thought. And what’s more, it actually has the potential to increase M&A activity in the financial sector.

The recent stress tests, conducted to provide an accurate view of banks’ exposure, have done little to waylay fears that banks are prepared for another financial crisis. Probably because of the fact that only seven out of 91 banks failed, criticism has been levied at the test claiming it was not tough enough to fail. This concern slowly gained credence after it was revealed that not all banks declared the full extent of their sovereign debt and that government bond losses were only applied to banks' trading books.

However, as things stand, banks still aren’t in too bad a shape. According to the WSJ’s, The Source, the recent calculations by Credit Suisse, show that it expects Basel III to cost banks €149 billion through higher capital requirements, capital deductions and loss of earnings – 39 per cent lower than its calculation three months ago. Furthermore, assuming that a minimum of six per cent equity in Tier 1 capital will be required, Europe’s banks should have excess capital of around €185 billion by the end of 2012. And even if regulators do go for an eight per cent capital requirement, they still have €80 billion to play with.

Therefore, despite not turning out to be quite a ‘fair’ test, the stress tests did do something else – they made some of the larger banks realise that they actually have more excess capital to play with than they originally thought, and significantly whilst analysing their business, they have come to realise that some of their Basel III short comings can be ‘patched’ through acquisitions of smaller banks whose assets and liquidity standings would help them plug their Basel III holes. It also emphasises the fact that the stress tests forced the banks to do some in-depth analysis of their operational metrics vis-à-vis an ideal Basel III framework and look at different measures to stabilise themselves from a long term perspective.

Basel III has also become an impromptu driver for M&A activity across various regions, providing banks – especially those with operations across multiple geographies – with a quick fix to make sure that they are secure. Naturally, this isn’t an option available to banks which operate in a limited geography - however, I wouldn’t be too surprised if the next six months started showing signs of closer co-operation between banks which have operations spanning numerous countries, as larger players gear up for some M&A activity aimed at global consolidation.