The Basel III regulatory framework, which comes into effect on 1 January 2019, may be only partially effective according to new research.
The research was formed by Swiss Finance Institute Professor Steven Ongena from the University of Zurich, and co-authors Professor Reint Gropp from the Halle Institute for Economic Research and Professor Thomas C Mosk and Carlo Wix from Goethe University Frankfurt.
The Basel III agreement looks to further increase the amount and quality of bank capital, enhance risk capture, contain leverage, improve liquidity, and limit procyclicality. With this reform, minimum capital requirements are increased by 50 percent, requiring banks to increase their risk-based capital ratios. Banks can do this by increasing the amount of regulatory capital they hold or by decreasing the quantity of risk-weighted assets they finance
The trio studied the impact of the 2011 European Banking Authority (EBA) capital exercise— which unexpectedly required certain banks to increase their regulatory capital ratios—on banks’ balance sheets and the real economy. Based on this, the researchers forecast that Basel III may induce banks to reduce the amount of assets they finance by lowering their credit exposure to certain businesses, but that they will likely not increase their amount of regulatory capital.
However, according to the research there are several reasons why the conclusions of the research paper are likely to be of a different magnitude following the implementation of the finalized Basel III reforms.
In particular, the 2011 EBA capital exercise was conducted in a fragile market environment dominated by the sovereign debt crisis, whereas today the economic cycle is on a stronger footing/
The finalized Basel III is not limited to capital ratios, but includes liquidity and leverage ratios as well. “Therefore, the implications for banks’ willingness to extend credit will be a blend of the impacts of these different regulatory measures,” the report said. “In particular, the reforms address all types of risk that attract capital—namely, credit, market, and operational risks—and do not focus only on credit risk requirements.”
Objectives of the reforms have included reducing excessive variability in credit risk risk-weighted assets (RWA) (between internal rate based approaches and standardized ones) with the additional aim to not significantly increase overall capital requirements, as publicly stated by the Basel Committee in March 2016.
The reforms have also increased the risk sensitivity of the credit risk framework, in particular for exposures under the standardized approach. According to the researches an important feature of the Basel III reforms is the timing of their implementation.
While the EBA required banks to increase capital ratios within six to nine months following the exercise, the Basel III reforms are expected to be implemented by 2022, with some important elements of the framework—such as the RWA floor limiting the difference between RWAs under internal rate based and standardized approaches—to be fully binding only in 2027.
“This timeline allows jurisdictions to adequately implement the new framework and provides banks with the opportunity to smoothly adjust to the new requirements, avoiding potentially negative consequences for the broader economy,” the report added.
Copyright © 2018 RegTech Analyst
Copyright © 2018 RegTech Analyst
