In December 2009 the Basel Committee on Banking Supervision released its consultative document “Strengthening the
resilience of the banking sector“. Since then negotiations between bank lobbyists, governments and regulatory bodies are at full swing. The proposed reforms of the committee (consisting of 27 regulators and central banks) are far-reaching for all market participants. What are the goals of Basel III:

• Raising the quality, consistency and transparency of the capital base
• Enhancing risk coverage
• Supplementing the risk-based capital requirement with a leverage ratio
• Reducing procyclicality and promoting countercyclical buffers
• Addressing systemic risk and interconnectedness

The current agenda foresees a legal implementation of the new framework by the end of 2012. Therefore the proposed numbers are still under discussion. Behind the curtain fierce negotiations are pending. Officially, comments on the consultative documents should be submitted by Apr 16th, 2010. Currently the following standards can be considered as likely:

• Increased emphasis on common (core) equity, the primary measure of capital. likely minimum requirement will be at 6%.
• A re-definition of eligible hybrids – excluding innovative hybrids from tier 1 due to their debt like features. Likely that existing instruments will be grandfathered. No clear indication what will be decided on non-innovative hybrids.
• Higher minimum tier 1 ratio – yet to be determined. Current negotiations might end up at 8% minimum requirement.
• Counter-cyclical capital buffer – in economic up-cycles, banks should hold excess capital above regulatory minimums, which can be run down in a downturn. A minimum buffer of 1% for 2012 in currently the most likely outcome.
• The Basel Committee proposes a supplementary leverage ratio. The calculation is yet to be defined. A minimum tier 1 at 4% of tangible assets is under discussion

Implications?

What can be expected now is rather vague. By mid 2010 model calculations regarding impact assessments should bring further insights. It will be expansive for banks by all means, most probably, raising significant amounts of fresh capital will be needed. One thing is predictable: despite the G20 committment, a political agreement will be difficult to reach, as, in the case of Basel II, the expressed interests are highly divergent. Some

• Germany would suffer from the abolition of hybrid bonds
• Specifics, such as silent participations, would come under pressure.
• Banks stress their concerns that credits will become more expensive for SMEs and private clients. Implicit message sent: we fear lower profitability. The latter is likely but yet too early to call.
• Another concern expressed by banks is the negative impact on GDP growth. Yet too early to call.
• A fund manager from Pivot Capital Management just recently raised the issue that Basel III will extend the sovereign debt bubble as it will discriminate all assets against governmental debt. His concern could have legs. The proposed draft suggests that a certain level of bank deposits needs to be invested in gov debt and deposited at the ECB for capital requirement reasons.

Overall, Basel III could be a needed and necessary cornerstone of global financial market reform. Tough negotiations ahead. Market Melange will keep you updated on further Basel III developments.

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(Markus Schuller´s original post was published on Market Melange)

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