Is it true that investors will lose money because of Basel III?
It is true. This is the price we pay because the banking system becomes more resilient. More risks, more profits - do you remember the principle? You cannot make much money in a "deep, liquid and transparent" market where you take limited risks.
Is it that simple? Less profit because of fewer risks?
There is a second reason.
The objective of the Basel III reforms is to reduce the probability and severity of future crises. So, we will face fewer risks. But this involves costs arising from stronger regulatory capital and liquidity requirements and more intense and intrusive supervision.
We will do have "benefits to the society that will well exceed the costs to individual institutions", but investors will pay the cost.
According to the Bank for International Settlements (BIS), banks may need to scale back their profit expectations.
According to the annual report of the BIS, we could have lower, more stable returns on equity (ROEs), a key measure of profitability, since bank balance sheets will be less risky.
There is a third reason also.
Basel III makes regulatory arbitrage harder.
Basel II allowed banks to play more games. Basel II mispriced the risk inherent in securitizations and let banks load up on off-balance-sheet instruments and collateralized debt obligations. Basel III adds a leverage ratio, and capital has to be at least 3% of total assets (TOTAL assets, not risk weighted assets).
Yes, Basel III introduces a simple leverage ratio that provides a backstop to the risk-based regime.
The supplementary ratio, which is a measure of a bank’s Tier 1 capital as a percentage of its assets plus off-balance sheet exposures and derivatives, will serve as an additional safeguard against attempts to “game” the risk-based requirements, and will mitigate model risk.
The packaging and selling of loans is no longer the great way to avoid capital requirements.
Banks must consolidate positions from all their trading desks and make their trading book compatible with their banking book (a read IT and data management challenge).
Another opportunity lost - it will not be that simple for banks to transfer assets out of their banking book into the trading book to get better capital treatment.
Oh, yes, this is going to be a real challenge for US banks that are not currently under the Basel II framework.
The moral of the story: Forget bank returns that are at the range of 20 percent.
I was surprised to read that Deutsche Bank AG is targeting a pretax investment bank return of 20 to 25 percent after 2013 (down from 28 percent in 2010).
Deutsche Bank AG may have to raise additional capital for another reason: Regulators have agreed to make as many as 30 of the world’s largest and systemically important banks hold as much as 2.5 percent more capital than the 7 percent core Tier 1 capital required.
This adds to the problem that banks cannot use hybrid capital instruments that are using now, such as contingent convertible bonds, to meet the target.
HSBC Holdings Plc (HSBA), Bank of America Corp. (BAC), Citigroup, Deutsche Bank, BNP Paribas, JPMorgan Chase & Co. (JPM), Barclays Plc (BARC) and Royal Bank of Scotland Group Plc may be subject to the surcharge of the 2.5 percent.
UBS AG, Credit Suisse, Goldman Sachs Group Inc. and Societe Generale may be subject to a lower charge of 2 percent.
The size of the potential market for contingent convertible bonds (CoCos) in the UK has already shrunk by two thirds, as banks cannot count the instruments as capital cushions, according to an analysis by Bank of America/Merrill Lynch.
The U.K.’s Financial Services Authority has asked banks to prepare a “flight path” to put them in compliance with the Basel III capital rules, taking into account dividends, bonuses and stress testing (they must take into account the possibility of another economic recession).
Paul Tucker, Deputy Governor of the Bank of England, challenges banks and asks them to build up capital ahead of the Basel III requirements (rather than using strong earnings to make payouts to staff and investors).
In the States, although major banks try to keep a brave face, they have already challenged Fed Chairman Ben S. Bernanke on whether regulators have gone too far and are slowing economic growth.
According to Mario Draghi, incoming European Central Bank president, banks already claim that opposing jurisdictions seek to water down Basel, and at the same time these banks have tried to weaken Basel III within their respective jurisdictions.
The Basel iii Compliance Professionals Association (BiiiCPA) is the largest Association of Basel III professionals in the world - http://www.basel-iii-association.com.
George Lekatis is the General Manager and Chief Compliance Consultant of Compliance LLC, a leading provider of risk and compliance training and executive coaching in 36 countries.
George has more than 17,000 hours experience as a professional speaker and seminar leader. He has worked for more than 15 years as a management consultant and educator and has demonstrated exceptional presentation and communication skills.
George is the president of the Basel ii Compliance Professionals Association (BCPA, www.basel-ii-association.com), the largest association of Basel ii professionals in the world, the Basel iii Compliance Professionals Association (BiiiCPA, www.basel-iii-association.com), the largest association of Basel iii professionals in the world, the Sarbanes Oxley Compliance Professionals Association (SOXCPA, www.sarbanes-oxley-association.com), the largest Association of Sarbanes Oxley professionals in the world, and the Solvency II Association (www.solvency-ii-association.com), which is also the largest Association of Solvency II professionals in the world.
George is an expert witness, qualified to investigate and testify about risk and compliance management standards, policies, procedures, best practices, due care and due diligence.
President of the Basel iii Compliance Professionals Association (BiiiCPA)
General Manager and Chief Compliance Consultant, Compliance LLC
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