“Though not a banking nor a treasury experienced professional, I have always had an interest in Basel Regulations, so thank you for sharing this!”
“Interesting – good video and the debate is ongoing.”
“A valuable perspective I must say…”
“I was attending the Supply Chain Financing Conference at the International Chamber of Commerce, Paris October 2012. A huge discussion point during the breaks of the actual conference was the need for corporate treasurers to start speaking out against the problems in the new regulations of the financial industry. Thus I fully support your work in Treasury Peer” Henrik Amby, Treasurer
“Many thanks. I liked the succint presentation of the key ideas and metrics associated.”
10 January 2013 update here.
18 November 2012 Philippe Roca has been kind to provide an update of the Basel III progress below the videos.Basel III Related Blog Articles
Together with our good friend Philippe Roca at the Corporate Funding Association (CFA) we’ve compiled the Treasury Peer’s Basel 3 for Dummies. The purpose is to provide you with a quick insight into this very important regulation. At its present construct it severely disrupts bank financing to corporates reallocating banks’ lending from the private to the public sectors. The Basel III framework has been developed by the Bank of International Settlements in Basel, Switzerland and pushed further by various other regulatory bodies. This text has several and significant shortcomings as do all “Dummies” since we have had to condense several hundreds of pages.
When you read this text please remember it only describes the Basel III framework so do not forget the adverse effects for corporates added from the Tobin tax and the risk of high large margin calls required for hedging by the new OTC derivatives regulation. Additionally we have the general crowding out effects from sovereigns hovering cash from the investors.
Basel III is divided in two main areas:
Banks shall progressively reach a minimum solvency ratio of 7% as of 2019:
So, what is the problem, if banks already exceed the minimum solvency ratio set by Basel III? The devil is in the details and here is where we find the problems caused to the corporate sector:
Banks will have to comply with two new ratios:
LCR: high-quality highly-liquid assets available must exceed the net cash outflows of the next 30 days:
NSFR: long-term financial resources must exceed long-term commitments (long term = and more than 1 year):
Hedging is penalized decreasing the liquidity in the markets leading to increase in costs to hedge the operational financial risks of corporations. This is further emphasized by the penalization of the interbank markets through requirement of more capital, and additional constraints on liquidity on interbank transactions.
Corporate credit by banks is penalized:
Other businesses areas threatened:
Overall, the main revolution for banks is in the liquidity ratios (LCR and NSFR), whose definitions are very severe for the corporate sector. For example, the average French banks’ LCR would have been around 58% at the end of 2009 if calculated to the Basel III definitions. Also consider:
Overall, Basel III aims to sharply deleverage the economy threatening economic growth at the same time as the debt crisis puts a pressure on governments to spend less. There is also some level of naivety in the provisions of the definition of “high-quality highly liquid” assets, which banks shall hold abundantly in their balance sheets to face their short term liquidity commitments. In fact the banks are pushed to hold huge amounts of sovereign debt…
The need to deleverage the economy is obvious however the way Basel III is designed has led to that the corporate sector to a large extent must rely solely on funding and hedging from outside of the banking sector. The basic role of redistributing financial risk and fund trade has in fact mostly been pushed out from the banks.
Listen to video presenting the philosophy of the Basel Framework:
18 November 2012, Philippe Roca shares this update of Basel III and adds a couple of comments
Since “Basel III for Dummies!” was originally launched, the project of this new regulatory mainframe has not changed. The content of the blog article was confirmed by brilliant presentations which some treasurers of Treasury Peer™ were lucky enough to attend May 2012 in London.
Banks are still negotiating the asset and liability management ratios (short-term “Liquidity Coverage Ratio – LCR” and long-term “Net Stable Funding Ratio – NSFR”). At this stage, it cannot be taken for granted that they will obtain these ratios to be softened. Yet, some definitions should be made more precise, which can be also a way to soften a couple of things. Read blog on the positive outcome (Jan 10 2013).
Treasurers often mention additional capital requirements for banks due to Basel III as a feature which hardly penalizes corporate lending. The additional capital requirements are not due to a change in the risk-weighting of loans to corporates but merely to the change in the definition of instruments eligible as regulatory capital for banks: this aspect affects similarly all the activities of the banks, and not especially corporate lending. Basel III changes risk-weighting for inter-bank lending and for some market transactions, it has not changed it for corporate lending. However the underlying attitude in the standard risk weightings imply that, at same rating, sovereign risk is lower. This attitude could have been expected to influence the general risk perception.
The implementation of assets and liabilities management requirements is probably more revolutionary for the banks’ business model than the additional capital requirements.
The Basel Committee does not impose regulation: individual jurisdictions have to elect whether they implement or not the bodies of rules proposed by the Committee and to what extent. The European Commission has adapted the Basel III regulatory mainframe with Capital Requirements Directive IV (CRD IV). Basel III itself was not completely taken as such into CRD IV and some concessions were made to banks over a couple of topics (for instance for the treatment of investments in insurance companies).
The Financial Stability Board made recommendations in July 2011 to the G20, and these recommendations were adopted by the G20 in November 2011. These recommendations gave birth on June 6th 2012 to a proposal of the European Commission to the European Parliament “establishing a framework for the recovery and resolution of credit institutions and investment firms”: banks would have to build recovery and resolution plans and have them validated by the banking supervisors. This directive would introduce bail-in in 2018. This tool would enable the banking authorities to write down the unsecured debt of a bank and to convert this debt into equity if it appeared to be necessary to avoid bankruptcy for an ailing bank; the portion of unsecured debt converted into equity would be left at the appraisal of the banking authority. All the liabilities (including derivatives) of the bank could be converted into capital except:
In March 2012, the European Commission also published a new directive which is to come in force as of January 1st 2013 in order to contain risks on OTC derivatives (EMIR – “European Markets Infrastructure Regulation”). This directive is a consequence of the G20 meeting in Pittsburgh in 2009. The purpose of EMIR is to reduce counterparty risks on derivative transactions, by an increase in collaterals and reporting obligations. It is the equivalent of the Dodd-Frank act.
In October 2012, the Liikanen report suggested that banks should run proprietary trading and significant trading operations into separate entities to cut them from deposits and governments’ guarantees. It is an equivalent of the Volcker rule in the US and of the Vickers report in the UK.
Under the pressure of markets and of the European Commission, in three years, banks have caught up the gap between their solvency ratios as of December 2009 and the Basel III objective which was set for 2018. This was made through various ways:
But deleveraging was not encouraged only by the additional capital requirements resulting from Basel III. Deleveraging was already made necessary by the liquidity ratios introduced by Basel III and by the difficulties of banks to raise long-term senior unsecured funding:
Banks encourage corporates to issue debt on capital markets and to reduce banking credit; credit facilities are less than ever expected to be drawn down; and the excess of cash raised on the capital markets are expected to be deposited into banks. Thus corporates which can contribute to the banks’ liquidity will get credit facilities from them. That is one of the reasons why some corporates see their supply chain or their clients struggling to get financing if their size is not sufficient to get funding from the capital markets.
For regulatory reasons (LCR and upcoming bail-in tool), banks are now requesting from their clients that term deposits benefit from a 32-day notice for early repayment.
Due to the lack in confidence, banks have been collateralizing more and more their long-term funding with their best assets:
The upcoming bail-in tool encourages such behavior. It makes the position of banks’ senior unsecured creditors increasingly subordinated. Banks struggle to issue long-term senior unsecured bonds on the markets. When they manage to do so, they pay credit spreads which are much more in line with BBB-rated corporate issuers (which is actually the average intrinsic credit rating they are given by Moody’s, before the impact of systemic support). In these conditions, it may be difficult for the banks to sustain providing long-term credit to corporates and, even more, to SMEs.
End of 18 November 2012 update. Thanks Philippe Roca for sharing.