As financial crisis looms large, most banks across the globe are showing remarkable alacrity in lapping up the recommendations made in Basel 3 as promulgated by the Basel Committee on Banking supervisions or BCBS. What transpired as an attempt to usher-in
reforms in the late 80’s to urge banks to maintain adequate capital and liquidity positions, has now been refined to an extent that such financial institutions across the world can relate to and adopt. A lot of traction can now be heard of, with banks inching
towards implementing Basel 3 norms. For example, with EU finally signing the draft on the capital requirement directive (or CRDIV), it is now almost certain that implementation will start rolling from January, 2014.
As banks ready themselves to brace Basel 3 recommendations by the beginning of next year, it’s imperative that they need to reinvent their business models and processes without losing sight of their bottom lines and shareholder value. Following are some
pointers that banks would need to address for implementing Basel 3 and it’s related impacts.
Mix of Capital: Basel -3 proposes an increase of tier 1 capital from 2 to 4.5% which will compel banks to plough back profits into retained earnings, that in turn means less dividends for it’s shareholders. The other way a bank can look at is raising
common equity which comes at a cost. Strategic moves like selling of business units or change of shareholding patterns maybe witnessed in response to effective capital management.
Quantity of capital: With Basel-3 including instruments like derivatives, repo style transactions and Security finances in the gambit of high risk assets, banks would need to optimize their Risk weights for these assets and also provide higher capital.
On the other hand, steps to increase tier 1 capital, reduction of tier 2 capital and complete elimination if tier 3 capitals will culminate into reduction of capital available currently in the bank’s kitty. The increase in RWA with subsequent reduction of
capital will require a higher capital ratio (calculated as capital / RWA). To address this issue, banks would usually tend to lend less and also put stricter controls on it’s credit evaluation process. Such measures would in turn preclude startups and small/medium
enterprises from availing hassle free loans. It should also impact large corporates who bank on these high yields-risk sensitive instruments.
Leverage and liquidity Ratios: The introduction of short term Liquidity Coverage Ratio (or LCR)and Net Stable Funding Ratio (or NSFR) will imply that banks would need to focus more on long term lending and look at stable funding sources. LCR would
mean that banks now will need to hold more short term liquid assets which by nature would be low yielding (read as les profits). Long term commitments like these shall have to be intuitively structured and priced sensitively. Banks would need to move from
vanilla pricing to a more scientific risk based pricing approach. Also a leverage limit of 3 percent may act as a damper for a bank which is aggressive in the lending space.
As further intricacies of Basel 3 implementation are still being worked out, banks and regulatory bodies are putting in considerable efforts to prepare themselves for the D–day. Though implementing Basel may prove to be a bumpy ride but the journey shall
be worthwhile if bank’s can finally establish itself as safe havens for it’s investor ‘s money and confidence in the long run.