Basel III In The Works: New Capital And Leverage Framework For Banks

Banks and bank-like entities were at the epicentre of the Great Global Recession, and there’s more than a few criticisms that the current prudential financial framework (aka Basel II) contributed to the crisis by being too pro-cyclical. The proposals for Basel III would tighten capital requirements significantly, though not to the point of killing banks’ ability to funnel credit to the economy at large:

Basel Capital Ratio Compromise Reached, Zeitler Says

Sept. 8 (Bloomberg) -- Global regulators reached a compromise on capital ratios for banks that will introduce higher capital requirements over a five- to 10-year period starting in 2013, a German central bank official said…

…Policy makers are seeking to raise the quality and quantity of reserves held by banks to avoid another financial crisis. Governments have been wrangling over the details with France and Germany among those concerned that their banks and economies wouldn’t be able to bear the burden of tougher capital requirements until economic recoveries took hold. Group of 20 leaders meet in November in Seoul to approve the rules.

Die Zeit newspaper reported Sept. 6 that the Basel Committee met to discuss a proposal demanding a minimum capital ratio for financial institutions of 6 percent as well as a “conservation buffer” of 3 percent for bad times. The proposal would have required an additional “anti-cyclical capital buffer” of 3 percent during “boom times,” the newspaper said.

As to the level of capital ratios, the committee has found a compromise as compared to the proposal,” Zeitler said. He didn’t reveal any numbers.

The compromised proposal is for 9% tier 1 capital ratio, up from the 8% total capital ratio under Basel II (The Economist Free Exchange blog has some of the details). If I remember the capital categories correctly, that’s a hefty increase – pretty much double what most banks are required to set aside under Basel II. There’s also going to be a maximum leverage ratio to be applied for the first time – the leverage ratios for US and European banks pre-crisis were mind-boggling.

I’d add to my wish list uniform accounting rules in the treatment of derivatives, but that’s probably not on the cards just yet.

How will this affect Malaysian banks? We’ve still got a couple of years to go before Basel III comes into effect, assuming it’s ratified that is, so there’s still time. Capital ratios for banks in Malaysia are in the low teens, but that includes Tier II capital such as subordinated loans which won’t count towards the new capital requirements. Another factor is that Basel III requirements specify absolute minimums, and you’ll always need a further buffer to allow for loan and asset growth.

Bottom line: there will have to be a round of equity capital raising over the next couple of years as Malaysian banks top up their capital bases, but loan growth (and thus support for economic expansion) shouldn’t be affected in the interim.