Basel III banking rules: feel the excitement

Banks are a key part of our interconnected economy. They match the differing needs of savers and borrowers.

Savers deposit their money in a bank in the expectation that their money will be protected – and that they will be able to access it whenever they need or want to. Borrowers then can use that money as a loan to build a house or start a business.

But banks are not only on this Earth to safely look after your deposits and loan you money to support your business expansion or buy the house of your dreams – although all those things are good for the economy.

Banks also generate real wealth, and this is one reason why governments are so keen to support the growth of the financial services sector. Basel III is just one of a number of attempts by central bank governors and banking supervisors to persuade banks to be less risky investors – and in doing so make the banks themselves better investments.

Basel III is a theme that sometimes stimulates conversation between bankers and, I must sadly admit as an accountant, can be something of a fixation for financial services professionals. However, it is not often a top-of-mind issue at weekend get-togethers.

Recent turmoil in financial markets – with a significant drop in the oil price, the Chinese government stepping in to prop up speculators and the ramifications of the Greece situation still stalking European finance ministers and central bankers – may make Basel III a little bit more topical.

The global economic crisis of 2007 and 2008 provoked a fundamental restructuring of the financial sector’s approach to risk and regulation. The Basel committee on banking supervision designed a raft of reforms to “strengthen global capital and liquidity rules with the goal of promoting a more resilient banking sector”.

There are three main components to the plan – capital reform, liquidity standards, and systemic risk and connectedness. Each has its own consultation, debate and implementation stages, raising levels of dynamism, complexity and interdependency but adding significant implementation challenges.

Implementation dates have been delayed, mostly because of pushback from French and German banks, but two of the standards, capital reform and liquidity requirements, come into effect at the beginning of 2017. The third, a supervisory risk framework for measuring and controlling large exposures, will take effect at the beginning of 2019. None of these dates is very far away.

Banks in the 19 member countries – which include most of the G20 – are already complying with the liquidity directive. Many other countries, including the UAE, have issued guidelines on the steps to compliance with Basel III liquidity rules and are expected to issue more detailed guidance shortly.

As the name perhaps suggests, Basel III is a continuation of a process, also including Basel I and Basel II, focusing on the level of capital that has to be set aside by banks to cover the risk caused by lending money. Some lenders are more likely to repay loans than others, which makes calculating the amount of money that has to be kept in reserve to cover the risk of the lender defaulting (or, in the Greek example, asking for a haircut) quite difficult.

Basel III requires banks to hold an increased amount of top-quality capital, which should make them better-prepared for another financial meltdown. It is designed to remove uncertainty in the banking sector and the wider financial services sector, and to ultimately give all investors greater confidence that they will be able to access their money in bad times as well as good.

So why does Basel III matter? It matters because banks are expected to improve their capital ratios, which are a reflection of a smaller amount of better quality capital and more assets with greater risk coverage. This will result in less liquidity in the global capital system.

Expect weaker banks to struggle to raise the required capital, potentially reducing competition. Look out for significant pressure on profitability and returns, with investors likely to receive smaller dividends when banks want to rebuild and restore buffers. Anticipate more longer-term funding arrangements. Also, expect to see an increase in reorganisations, including mergers and acquisitions and disposals of portfolios and entities.

While Basel III reduces the risk of a systemic banking crisis, the way it does so reduces lending capacity and investor appetite for bank debt and equity, and could lead to inconsistent implementation.

So Basel III – which perhaps seemed like a dry, uninteresting topic that only accountants and bankers could discuss with relish – is becoming more relevant, and immediate, for all of us.

Austin Rudman is a partner at the auditor KPMG Lower Gulf.

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