Financial Regulatory Forum

ANALYSIS – Tough Basel rules to boost banks’ long-term allure

By Reuters Staff
January 26, 2010

By Dominic Lau

LONDON, Jan 26 (Reuters) – Stricter global banking rules will add to short-term headwinds facing European banks and hurt their shares, yet details being hammered out could make them more alluring for more risk-averse long-term investors.

The Basel Committee of central bankers and financial supervisors is seeking to avoid a repeat of the credit crunch and reduce the industry’s cyclical volatility by raising the quality of banks’ capital, after many of the assets they were using crumbled during the crisis.

U.S. President Barack Obama has also laid out rules to restrict some banks’ most lucrative operations.

Investors looking for quick returns may not like these ideas. The banking sector, which rallied sharply in 2009, is also under pressure from the prospect of central banks gradually withdrawing liquidity this year and from rows over bonuses.

But the tougher regime, with the Basel proposals taking effect by end-2012, may not be bad for long-term players.  (For scenarios on possible impact of Basel proposals, click here)

“Regulation is a great thing. The last thing anybody wants to go through is the experience we had last year,” said Mark Bon, fund manager at Canada Life.

“As a long-term investor, you don’t want hidden assets in things where the banks themselves don’t know what they are doing and (banks) losing a huge amount of money and then expecting shareholders to bail them out every 10 years.”

Having survived the economic turmoil with rounds of fundraisings, banks would have to set aside more money or raise capital as protection against hard times, hurting their share performance in the near term.

Credit Suisse estimated a bigger capital buffer could cost European banks 139 billion euros ($197 billion) by 2012, while Deutsche Bank said the Basel plans would make the industry more like the utility sector — which some investors favour for its more predictable if traditionally less spectacular returns.

The new regime would, for instance, assess Barclays’ equity Tier 1 ratio — a measure of its financial strength — at just 5 percent rather than the current 9.6 percent. The bank would need to raise 17 billion pounds ($27 billion) to meet capital requirements, according to Credit Suisse.

European bank shares have surged 140 percent since hitting a low in March 2009, but are still down over 60 percent from a high reached in April 2007 before the credit crisis hit.

“I don’t like bank shares. After the rally last year, they are expensive. They are going to have to raise more capital under Basel,” said Robert Parker, vice chairman at Credit Suisse’s asset management arm.

“There will be further writeoffs. They are going to cut leverage … therefore their revenue generation ability is more constrained. The big source of profit — the credit rally in 2009 — is over.”

Parker said he would look at banks only in two to three years’ time, once they had worked through the writeoffs.

The International Monetary Fund estimates top U.S. and European banks have lost more than $1 trillion on toxic assets and bad loans since the start of 2007, and expects this to top $2.8 trillion for 2007-10.

The Basel committee wants the first-ever global introduction of a leverage cap. It also wants to restrict the types of capital a bank can use to prove its financial stability.

Meanwhile Obama’s plans, which require congressional approval, would prevent banks or financial institutions that own banks from investing in, owning or sponsoring a hedge fund or private equity fund. He also wants to bar institutions from proprietary trading operations for their own profit.

SELECTIVE EXPOSURES

“You will find that a lot of institutions have already made quite substantial reductions in their proprietary trading,” said Stephen Pope, chief global equity strategist at Cantor Fitzgerald in London.

Pope said investors would not desert the sector but would be more selective.

Deutsche Bank expects smaller Spanish and Italian banks to suffer less under the proposed changes in Tier 1 capital requirements, while Dexia, Credit Agricole, Lloyds Banking Group and UBS could be the most affected.

As for the proposals on stable funding, Deutsche Bank expected those with loan-to-deposit ratios under 100 percent and simple retail focused business models to be less affected.

These included Swiss banks, Spanish banks, Italian banks, HSBC and Standard Chartered, while British, German and French banks could be the worst placed on this basis.

Merrill Lynch said Nordic banks would have little problem in meeting the minimum Basel requirements.

Others said banks with emerging market exposure might have an advantage. “They have tentacles everywhere (to offset) a lot of pressures in domestic markets — the key Western markets,” said Robert Quinn, European strategist at Standard & Poor’s equity research.

(For an outline of the Basel committee proposals, click here)

(Editing by Ruth Pitchford)

((dominic.lau@reuters.com; +44 20 7542 5440; Reuters Messaging: dominic.lau.reuters.com@reuters.net))

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