Last Sunday afternoon the Group of Governors and Heads of Supervision, which is the oversight body of the Basel Committee on Banking Supervision, announced the finalized version of Basel III. The committee, meeting in Basel, Switzerland, is composed of representatives of the top 27 global central banks. Basel III was supposed to require banks to raise capital ratios in the hopes of preventing another financial crisis. Will these increased capital requirements make the financial system safer? I guess, as always, it depends on who you ask.
Today I thought we might look at the Basel III regulatory changes through the eyes of a few key constituents. But before we do that, let’s take a quick, if oversimplified look at what’s in Basel III, quoting from a Wall Street Journal article that described the basics:
- Large, internationally active banks will have to hold levels of common equity equal to at least 7% of their assets, much higher than the roughly 2% international standard or 4% standard for large U.S. banks.
- By 2015, banks will have to begin building a 2.5% “buffer” of capital that must be fully in place by Jan. 1, 2019.
- If banks fall below the buffer, regulators could force them to hold onto more of their earnings to augment their capital, which means the companies will have less money on hand to pay dividends or offer large compensation packages.
Basel III: Boon or Bane?
Basel III has been debated, anticipated, and repudiated for months. Now that it’s arrived, only the anticipation is over. The debating and repudiating continue. Here are some thoughts on the efficacy and implications of these new regulations:
Most bankers would have liked the capital requirements to be lower and less stringent, but their overall reaction seems to be one of relief. While the capital ratios aren’t the ones they would have preferred, they are grateful that they weren’t even higher. They are also relieved that they will have nearly a decade to fully implement all of the new requirements. The markets rallied as investors were also relieved that the new requirements won’t hurt bank earnings as much as anticipated.
Most global governments are anxious to show Main Street that they are reining in the financial institutions that took on too much risk and came precariously close to destroying the global financial system. They hope that these regulations will do the trick and that the average consumer and investor will be confident enough to hit the mall and buy some stocks. That’s a pretty tall order, considering that most Main Street constituents would rather earn less than 2% on a bond than take the risk of investing in a company that pays a dividend of 4% or better.
Much like the politicians, central bankers want to be seen as “on the job”, doing what it takes to protect the integrity of the financial system. They have struggled to find a happy medium between the demands of the bank lobbyists and those of the torch-wielding posses forming on Main Street. They definitely don’t have an easy job. Cynics, however, would point out that we wouldn’t be in this mess in the first place if they had done their jobs correctly in the first place.
I don’t have any formal statistics on this, but I’m going to guess that the average person doesn’t know or care what Basel III is. That doesn’t mean that it won’t affect them. Many are already speculating that banks may raise fees in order to meet the new capital requirements. That could mean the end of no-fee chequing accounts and free online banking.
Bank of Canada Governor Mark Carney suggested that banks should consider cutting compensation expenses in order to meet the requirements rather than laying the costs off on already-struggling consumers. He also said that they could alternatively raise capital or increase their retained earnings. Raise your hand if you think they’re going to cut their salaries. . . Anyone?
Many observers like Dennis Gartman have pointed out that the time lag to full implementation is unnecessary and gives the banks a lot of leeway to figure out how to circumvent the new requirements – if they haven’t already been repealed by 2019. He also raises the concern that giving the banks 9 years to comply means that their balance sheets might be in worse shape than we have been led to believe. Given the balance sheet voodoo surrounding the subprime crisis, that doesn’t seem so far fetched.
Other critics have pointed out that the new regulatory requirements rely too heavily on the wisdom of regulators who have already proven to be sleepy stewards of safety. Perhaps even more significantly, Basel III does nothing to address the continuing lack of transparency in the marketplace. It’s just more pruning leaves rather than hacking roots.
What Does It Mean to You?
The average citizen is not likely to notice a lot of changes right away, but the idea of banks raising fees bears watching. The banks can raise fees if they want to, but don’t forget that it’s your prerogative to take your money where it will be treated best. If a fee-raising trend arises, there are bound to be counter-trends as well. Maybe some banks will offer free banking as an incentive to garner more of your business or in exchange for some other trade-off. It will be important for consumers to remain vigilant and be prepared to roll with the punches as they come.
If you invest in financial institutions individually or through funds, it might also be a good idea to keep an extra close eye on earnings reports and financial statements. Banks that are struggling heading into these changes may face accelerated challenges as they work to achieve compliance. Watch for the wheat to separate itself from the chaff.