Policy Implications For Completing Basel III Regulations For Banks

Running head: BASEL III

Policy Implications for Completing Basel III Regulations for Banks

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Policy Implications for Completing Basel III Regulations for Banks

Introduction

The global financial crisis has at least indicated that the stability of price does not

necessarily guarantee financial stability. In essence, the business cycle and financial cycle are not

synchronized, meaning that there is a potential for risks emerging particularly when the two

cycles are disconnected from one another. During the wee years of the financial downtown,

inflation was stable and low while there was gearing up of imbalances. In the current

perspective, the hunt for yield phenomenon is ongoing against the environment of very low

inflation, low rate of interest, and subdued growth (Aoki, and Nikolov, 2014).

The core aim of the global regulatory changes and monetary policy had been to establish

the stability of prices for goods and services in the market. It was not purposed to address

instances of instability in asset market environment. This falls within the jurisdiction of the

macro-prudential global policy which is focused at enhancing the stability of the global financial

system, as well as in managing and evading systemic or systematic risks. Currently, in the

developed market economies, there is a need for a strong monetary policy that will work towards

stabilizing prices, as well as in providing support for real activity whereas; the macro-prudential

policy is required for the purpose of taming the financial sector in the asset market that harbor

signs of imbalances and exuberance (Ari, Kok, Paries and Żochowski, 2015). The purpose of this

paper is to undertake a critical analysis of the policy implications of the Basel III implementation

on international banks expanding into the UK.

Overview of the Basel III Regulations

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"Basel III" refers to an extensive set of reform regulations that were established by the

Basel Committee on Banking Monitoring for the goal of strengthening supervision, regulation

and risk management within the banking sector. The core goal of these measures were to a)

reinforce the disclosures and transparency of the banks, b) improve on the governance and risk

management, c)enhance the ability of the banking sector in absorbing socks emanating from the

financial economic and financial distress, whatever the source it may be. The key target of these

reforms is on micro-prudential regulation, and the banks which help in raising the pliability of

the banking sector especially during the time of economic and financial stress. Furthermore, the

regulations also target the risks that are system wide or macro-prudential which have a potential

of building up across the banking institution alongside the procyclical amplification of such risks

over a given time frame (Slovik; AND Cournède, 2011).

The two supervision approaches (that is, microprudential or bank level and, or macro

prudential) complement one another since a higher resilience at the bank level has been found to

harbor a potential of reducing the risk of system wide shocks. In essence, Base III was instituted

as part of the regular efforts in enhancing the regulatory framework of the banking sector. It is

basically derived from the international Convergence of the Capital Standards and Capital

Measurement document (which is Base 11) (Bank of International Settlements, 2014).

How has Basel III Helped Banks in Mitigating Shocks in the Financial Market, as

well as in Ensuring Financial Stability?

The key aim why Basel III reforms were reforms was to curb the severity and probability

in the occurrence of future crises. This subsequently lead to a requirement of a stronger liquidity

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and regulatory capital requirement as well as a more intrusive and intense supervision of which

various individual institutions will find as being costly. Despite this, an analysis by Walter

(2011), and research indicates that the benefits associated with such an endeavour far outweighs

the costs associated with them. Furthermore, an analysis by the Committee on banking

supervision (2010) on the long term economic effect of the Basel III adoption by the individual

institutions established that liquidity and capital requirements had increased to a significant level.

In addition, the net economic benefits to these institutions were generally positive.

The study findings are not astonishing. It is generally accepted that discreet monetary and

fiscal policies are the basis of sustainable economic development and financial stability. In

essence, establishing and maintaining conformist inflation and fiscal policies normally comes

with a cost, and could potentially reduce an institution’s economic growth for a short term basis.

However, this will be offset by a long time growth and which is more sustainable. Similarly,

effective enhancement of the stability of the financial and banking sector may entail a

comparable trade-off whereby; despite inherence of a significant level of costs, these costs may

be offset by a longer term benefits. Particularly, there is no country in the world that can

possibility be in a position of maintaining sustainable growth on a long time basis on the basis of

a weak financial system (Walter, 2011).

According to BIS (2010), the reforms in Basil III have raised both the quantity and

quality of the regulatory capital foundation while also enhancing the coverage of risks in the

framework. The author explains that the reforms are underpinned by a forceful ratio which

serves as a backstop to the measures of the risk-based capital. Furthermore, the intent is to

constrict the excessive leverage within the banking institution while also providing an additional

stratum of protection against measurement error and mode risk. Moreover, the macroprudential

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elements incorporated into the regulatory framework were also intended to assist in helping

containi systemic risks derived from the interconnectedness and procyclicality of financial

entities.

It should be considered that Basil III framework was instituted as a response to the

shortcomings of the existing regulations and frameworks. Consequently, the reforms in Base III

have raised the requirements for capital for the complex securitisation exposures as well as

trading book, considered to be the main source of the losses that were realized by various

internal banks. Apparently, the enhanced framework has incorporated a capital requirement of

the a stressed value-at-risk (VaR) which is based on an incessant 12 month period of a

noteworthy financial distress. Another additional element in the new regulatory framework is the

requirement for a higher capital for resecuritisations in both the trading and banking sector.

Moreover, thanks to the new standards, the supervisory review process of pillar 2 had been

significantly raised while the disclosures in Pillar 3 have been significantly strengthened. These

are all significant achievements by the new Basil III regulatory framework which have

subsequently helped in mitigating shocks in the financial market as well as in ensuring the

banking institutions are financially stable.

The policy implications of the Basel III implementation on international banks expanding

into the UK

In UK context, the kind of changes envisioned by Basel III will raise the industry’s need

for additional capital which is expected to rise by 10% from €1trillion to €1 trillion. This

increase is stirred by various factors, both negative and positive. Some of the items that will be

deducted by Basel III from capital including hidden losses and DTAs will be manifested by

2019. This will help in reducing the shortfall in capital by €100 billion. In this respect, banks

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operating in the UK will be at a position of filling in some of their capital needs using their own

retained accumulated earnings. However, the institutions will also experience an increased need

for capital owing to the projected business growth in the financial sector. The underlying

projections by Global Insight Research Institute are that due to the application of the new Basel

III framework, the nominal GDP in Western Europe will rise by 3.5%. Furthermore, the

deleveraging impact, particularly in the United Kingdom, German and France, will significantly

reduce the growth of the balance sheets of individual banking institutions by approximately 3

percent. Nonetheless, the growth assumptions do not incorporate the wider business

restructurings that is likely to be taking place as a response of Basel III framework regulation

whose impact on growth may not be foreseen at the (Bank of International Settlements. 2014).

Furthermore, there will be an increase in costs for short term loans of up to up to 70 basis

points. The rise in target ratios for a business segment that harbour a higher level of liquidity,

risk weights and long term funding needs will ultimately contribute raising of the costs. In this

respect, banks operating in UK may be compelled to pass on these added costs to its customers,

taking into concern the high margin associated with financial and bank products. They may also

find reprising difficult for specific consumer segments (Ranjit, 2012).

There will be also a net effect on retail and corporate banking, basically owing to the

increase in the capital target ratios. The new ratios introduced by the Basel III will cause a

significant level of effect on standard corporate banking products. Long term corporate assets,

and long term corporate loans, (for project financial and commercial real estate) will encounter a

higher level of funding costs of approximately 10 basis points. There will be also a significant

cost increase of uncommitted liquidity and credit lines to corporations and financial institutions

by approximately 60 basis points because of the requirement for a higher liquidity. This is in

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addition to 15 to 25 basis points requirement for higher capital required. Since various markets

for corporate lending are quite sensitive to price, it may not be possible for many banks to fully

pass on such raises in costs. In the event that they will be unable to do this, the increased costs

will result into a reduction in revenue while lesser capital will be eventually allocated to such

businesses (Härle, and Lüders, 2010).

Other considerations for banks operating with the new framework in UK perspective is

the need to comply with the new mandate enshrined in the new framework such as the use of the

IFRS 9 standards in their accounting processes, aggregation of risk data and IT BCBS 239), and

the application of the new interest risk rate within the standards of the book banking. Under this

regulatory environment, banks will be required to incorporate implementation programs mainly

on a large scale basis. Furthermore, they will need to ensure that they have in place sufficient

resources so as to be able to meet their provisional needs, as well as in covering substantial one-

off expenses. What is more, the higher capital requirement imposed by the EU Supervisory

Evaluation and Review Process significantly raises the threshold of the capital as well as the new

requirements of the loss absorbency such as MREL/ TLAC which subsequently raises the costs

of refinancing owing to the issuance of applicable liabilities in loss absorbency. Nonetheless,

these endeavours may hinder buildup of organic capital while also raising the threshold of capital

requirement of the respective businesses (Schneider, 2017).

Conclusion

With the new banking regulation of the Basel III, it is almost mandatory that for

stakeholder institutions in the financial sector need to align themselves with the new liquidity-

measurement, the current capital, loss & profit accounting practices with the new framework.

Within the UK’s financial markets, it now necessary for financial institutions that want to thrive

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in the environment to make the necessary required changes to their business so that they will be

able to attract a positive treatment within the Basel III regulation with limited profit and loss

impact and limited revenue.

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References

Ari, A., Kok, M, and Żochowski, D. (2015), “Shadow banking in general equilibrium”, mimeo,

European Central Bank.

Aoki, H. and K. Nikolov (2014), “Bubbles, Banks and Financial Stability”, Journal of Monetary

Economics.

Basel Committee on Banking supervision (2010): An assessment of the long-term economic

impact of stronger capital and liquidity requirements.

Bank for International Settlements. (2010). Basel III: A global regulatory framework for more

resilient banks and banking systems. Available from

https://www.bis.org/publ/bcbs189.pdf

Bank of International Settlements. (2014). Basel III: international regulatory framework for

banks. Available from https://www.bis.org/bcbs/basel3.htm

Härle, P., and Lüders, E.(2010). Basel III and European banking: Its impact, how

banks might respond, and the challenges of implementation. 1 McKinsey & Company.

Retrieved on 9

November, 2017

Schneider, S. (2017). Basel “IV”: What’s next for banks?. Global Risk Practice April

2017, Retrieved on 7

November, 2017

Slovik, P., Cournède, B. (2011). "Macroeconomic Impact of Basel III". OECD Economics Department Working

Papers. OECD Publishing.doi:10.1787/5kghwnhkkjs8-en

Walter, S. (2011). Basel III: Stronger Banks and a More Resilient Financial System.

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Financial Stability Institute Basel 6 April 2011

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