Banks are reacting with a range of measures designed to improve capital ratios. These include cost cutting, the disposal of non-core businesses, issuing new capital, retaining more of their earnings (often through lower dividend payments), reducing on and off balance sheet exposures – and increasingly insuring against losses.
The new liquidity standards, meanwhile, pose a different challenge.
High quality liquid assets (such as retail customers’ savings, for example) pose a low risk but also offer a low return – so holding them reduces a bank’s profitability.
At the same time, it’s difficult for banks in aggregate to increase retail deposits – so increased competition for deposits is increasing their cost.
Similarly, increasing demand for longer-term wholesale funding is pushing up the cost of this funding to the banks.
In particular, the new liquidity requirements are causing problems for foreign banks funded either from their home markets or by means of wholesale funding. While many of these banks play a major role in the Asia Pacific sector, they lack a local deposit base.
Banks may therefore cut back on lending – with more than one-year maturity – that requires stable funding.
Some key regional comparisons
In the EU, Basel 3 has largely been copied into the latest Capital Requirements Directive (CRD4) in a bid to harmonize regulation across the union.
And more immediately, several European countries – along with the European Banking Authority (EBA) – have imposed tough stress tests based on capital ratios that are actually higher than those called for in Basel 3. For example, the latest EBA stress test requires major EU banks to meet a 9 percent core tier one capital ratio by June 2012.
In the US, where many banks boost capital levels that more than meet Basel 3 requirements, regulators have announced an intention to comply with that standard. As a result, many US banks are undertaking comprehensive firm-wide assessment exercises to better understand Basel 3’s capital and liquidity requirements and to begin to plan for changes to ensure compliance with its deadlines.
Many Asian countries, meanwhile, have imposed higher minimum capital ratios than those in Basel 3 – and have also accelerated the implementation timeline.