The Biggest Banks and Basel III

© 2014 Deena Zaidi. All rights reserved.

A focus on recent changes in Basel III

Central Banks and their regulations just got tougher. Basel Accord has always been a matter of debates amongst countries. Bank of International Settlements (BIS) BIS controls the capital adequacy ratios in banks and encourages reserve transparency. The BIS sets “requirements on two categories of capital, tier one capital and total capital. The United States of America in 2006, favored strong strict central controls in the spirit of the original 1988 accords, while the EU was more inclined to a distributed system managed collectively with a committee able to approve some exceptions. It is widely felt that the shortcoming in Basel II norms led to the global financial crisis of 2008. That is because Basel II did not have any explicit regulation on the debt that banks could take on their books, and focused more on individual financial institutions, while ignoring systemic risk. To ensure that banks don’t take on excessive debt, and that they don’t rely too much on short term funds, Basel III norms were proposed in 2010.Failure in the transparency of many banks that are governed by the central bank also has raised many issues regarding the transparency of the central banks and other banks under its umbrella.

© 2014 Deena Zaidi. All rights reserved.

Recently, Banks faced tighter rules on how much business they can do with each other. The Basel Committee on Banking Supervision published rules that from 2019 will cap one too-big-to-fail bank’s financial dealings with another at an amount no greater than 15 percent of its capital. As compared to its predecessors, Basel III is a risk-based system more complicated. It generally requires banks to hold more capital than they’ve had to in the past. In addition, Basel III includes a minimum leverage ratio for all banks and requires the banks to maintain a minimum amount of liquidity.  The leverage ratio or BCBS 270 is to reduce the banks’ ability to take on excessive risk. Basel III introduced a minimum “leverage ratio”. The leverage ratio was calculated by dividing Tier 1 capital by the bank’s average total consolidated assets. The banks were expected to maintain a leverage ratio in excess of 3% under Basel III. In July 2013, the US Federal Reserve Bank announced that the minimum Basel III leverage ratio would be 6% for 8 Systemically important financial institution (SIFI) banks and 5% for their insured bank holding companies. In January 2014, the definition of exposure was changed by BIS to include off-balance sheet transactions such as OTC derivatives, and required those trades be counted in gross notional value. The measures also refine an existing rule capping the amount of business that a bank can do with a single counterparty at no more than 25 percent of its capital.¹

© 2014 Deena Zaidi. All rights reserved.

A look at Europe & USAWith this news, a closer look at economies of USA and

Europe is but obvious since they have been culprits and

victims of the world global collapse and have bailed out

many of their banks. Mountains of bad debts, many not

yet written off, and the resulting shortage of capital are

restricting the flow of credit to the rest of the economy in

Europe.  In America, by contrast, regulators are ratcheting

up the levels of capital (mainly equity and retained profits)

they demand of banks, convinced that it will lead not just

to a safer banking system but also one better able to lend

to companies. On March 20, 2014, Federal Reserve

announced that 29 out of 30 major banks met the

minimum hurdle in its annual health check. The two

banking systems are not completely comparable, largely

because European banks hold large portfolios of

mortgages on their balance-sheets but the differences are

striking. Most big American banks are close to their new

leverage target of 5%, whereas many European banks

are struggling to meet the lower Basel threshold .

© 2014 Deena Zaidi. All rights reserved.

Conclusion

Bailing out big banks through tax payers’ funds is definitely not a wise choice. The credibility of banks need to be

tightened and made more transparent.  Basel should focus more on morality of banks and have strict regulations for

banks. Capital structures and leverage ratios are all part of banking and should be dealt with only once the

credible banks are distinguished from the fraudulent ones. Regulators should keep in mind that a small bank can have

more creditworthiness and faith amongst investors than a big fraudulent bank and bailing out the latter will only harm

the economy and shake an investors’ confidence. Having said that, it is important to keep in mind that failure of

banking system in the past happened not because of capital inadequacy but due to lack of liquidity. Too much lending

with less cash ( liquidity) can lead to serious issues. Eventually, the banks that fail know that they are big and will be

bailed out once a crisis occurs. Stringent laws need to be incorporated so that the ‘Too Big To Fail’(TBTF) theory is not

always correct. We need to understand that due to huge global connection of banks , such theories can cause more

harm to other nations. They might correct that specific country’s financial health but may cause serious damage to

other parts of the world. TBTF remains a debatable issue but we hope that Basel Accords will be able to do some

justice to the world banking system.

© 2014 Deena Zaidi. All rights reserved.