Global Bank Regulations – updated Basel 3
Global Banking regulators have determined to improve the quality and effectively to triple the size of the capital reserves the world’s banks must hold against losses and potential losses. These tougher capital standards are to be phased in over an extended period of time – mostly from January 2013 to January 2019, aiming to contribute to long term financial stability and not to curb global economic growth. Many large banks already meet or exceed the revised capital requirements. We believe regulatory clarity should therefore now provide better managed banks with the ability to increase their capital management activities via increasing dividends, share buy-backs and opportunistic acquisitions – to the advantage of shareholders.
At yesterday's meeting of the G-10 Governors and Heads of Supervision of the Basel Committee on Banking Supervision, new capital requirements and levels were agreed upon. These capital reforms, together with the introduction of a global liquidity standard, will be presented to the Seoul G-20 Leaders summit on November 11-12. The clear goal – stated by regulators – is that the revised capital requirements will increase the quality, quantity, and international consistency of capital; will strengthen liquidity standards; will discourage excessive leverage and risk taking; and will reduce pro-cyclicality of regulatory requirements.
Global Banking regulators have determined to improve the quality and effectively to triple the size of the capital reserves the world’s banks must hold against losses and potential losses. These tougher capital standards are to be phased in over an extended period of time – mostly from January 2013 to January 2019, aiming to contribute to long term financial stability and not to curb global economic growth. Many large banks already meet or exceed the revised capital requirements. We believe regulatory clarity should therefore now provide better managed banks with the ability to increase their capital management activities via increasing dividends, share buy-backs and opportunistic acquisitions – to the advantage of shareholders.
At yesterday's meeting of the G-10 Governors and Heads of Supervision of the Basel Committee on Banking Supervision, new capital requirements and levels were agreed upon. These capital reforms, together with the introduction of a global liquidity standard, will be presented to the Seoul G-20 Leaders summit on November 11-12. The clear goal – stated by regulators – is that the revised capital requirements will increase the quality, quantity, and international consistency of capital; will strengthen liquidity standards; will discourage excessive leverage and risk taking; and will reduce pro-cyclicality of regulatory requirements.
The required capital levels are:
Common Tier 1 Capital (previously 2%) to be: 3.5% ( by 1/1/2013) 4.0% ( by 1/1/21014) 4.5% (by 1/1/2015 and thereafter)
Tier 1 ratio ( previously 4%) to be: 4.5% ( by 1/1/2013) 5.5% ( by 1/1/2014) 6.0% (by 1/1/2015 and thereafter)
Total Capital ratio (previously 8%) to be: 8.0%
In addition
- A new capital conservation buffer of 2.5%, intended to ensure that banks are better able to withstand periods of economic and financial stress, so that, effectively the new ratios by 2015 will equate to 7%, 8.5% and 10.5% respectively. While banks will be allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions. The conservation buffer will be phased in from 2016 to 2019 in increments of 0.625%
- A new countercyclical buffer exists to combat asset bubbles, equating to a range of 0-2.5% of tier 1 common equity or other fully loss absorbing capital will be implemented, according to national circumstances, with the goal of protecting the broader banking sector from periods of excess aggregate credit growth. For any given country, this buffer will only be in effect when there is excess credit growth that is resulting in a system-wide build-up of risk.
This new countercyclical buffer would be introduced as an extension of the conservation buffer range when in effect. " The additional buffer is designed to protect against "periods of excess aggregate credit growth." According to the BIS' July consultative document, "this focus on excess aggregate credit growth means that jurisdictions are likely to only need to deploy the buffer on an infrequent basis, perhaps as infrequently as once every 10 to 20 years."
Extended phase-in period beginning on 1/1/2013 with transition required by 1/1/2019.
By 1/1/2013, member countries must translate the new rules into national laws and regulations and will be required to meet tier 1 common ratio, tier 1 capital ratio and total risk-based capital minimums of 3.5%, 4.5% and 8%, respectively. Thereafter from 2015 to 1/1/2019 the minimum conservation buffer rises from 0% to 2.5% in increments of 0.625%
Proposal to test a Leverage Ratio
The regulators also agreed to test a minimum tier 1 leverage ratio of 3%. Importantly, the new leverage requirement will be a non-risk-based measure designed to act as a supplement to the risk-based requirements stated above, and it will likely include derivatives and other off-balance sheet items in the calculation.
There will be a supervisory monitoring of this ratio over the period from 1/1/11 to 1/1/13 and then a parallel run period from 1/1/13 to 1/1/17. Disclosure of the leverage ratio and its components will start on 1/1/15, and based on the results of the parallel run period, any final adjustments will occur in the first half of 2017.
Systemically important banks should have loss absorbing capacity beyond the new metrics discussed above, according to the Basel Committee on Banking Supervision. This is relevant for most of the banks in which we invest but the majority of those already have exceeded the minimum levels even with the conservation and countercyclical buffers included. Nonetheless, there could be some additional capital raising on the back of supporting additional acquisitions and replenishing capital.
In summary
The new rules do reduce existing capital levels by phasing out / setting limits on some measures of quasi capital ( deferred tax assets, mortgage service rights and some capital instruments). However, the overall impact and extended period of implementation effectively result in the larger better managed banks already having excess capital. Current industry averages for larger global banks exceeds the highest minimum levels even with the conservation and countercyclical buffer included.
Wholesale funding remains problematic for smaller franchises, particularly as many are less well capitalized than their larger competitors and will see the upgraded regulatory standards as a threat. National bank champions are better capitalized and have better access to lower funding costs – both wholesale and retail - their consequent purchasing power supports our ongoing view that the financial services arena is both converging and polarizing the strong from the weak players. We believe, the market has yet to price the dichotomy – so presenting an attractive opportunity for those wishing to invest in strong franchises with both recovery potential and purchasing power.
We expect market sentiment will warm to the better managed banks as they are cheap on a Price/Earnings and Price /Book basis; their franchises are profitable even when their customers are frugal; capital and reserve levels are at all-time highs; and acquisition activity should begin to pick up as asset values stabilize and regulatory (as well as revenue) issues further differentiate the hunters from those on the menu.
