ANALYSIS-Europe’s banks face harsh reality of Basel III jolt

February 2, 2010

By Steve Slater, European Banking Correspondent

LONDON, Feb 2 (Reuters) – New rules on bank capital will jolt the industry and could force European lenders to raise more cash and restrain returns, dividends and pay for at least the next two years, analysts and industry sources say.

The impact of the proposals — dubbed Basel III — has been underestimated by investors and banks, and clarity on the new rules could be a shock, several analysts said.

The rules could drive the core Tier 1 ratios — a measure of a bank’s strength — at Lloyds Banking Group and Credit Agricole down to near 4 percent, require Barclays to plug a 17-billion-pound capital gap and hurt HSBC and BNP Paribas harder than peers.

Analysts at Credit Suisse said Basel III changes could cost Europe’s banks 139 billion euros ($195 billion), and cut their average equity Tier 1 ratio to 8.1 percent from 9.6 percent by the end of 2012.

“Changes in capital regulations will be a game-changer for the industry,” said Andrew Lim, analyst at financial services firm Matrix. “Clarity on winners and losers will come to the fore quicker than people are expecting.”

Basel III has been overshadowed by a U.S. crisis tax, bonus taxes and the U.S. proposed “Volcker Rule” that could change the face of banking. But it is likely to be more significant and force more lasting change on Europe’s banks.

Regulators want to increase the quantity and quality of capital held by banks and remove complexity and inconsistencies from balance sheets.

Ideally, capital would show clearly what cushion a bank has to protect depositors and help prevent a repeat of the rescue bailouts seen during the last 18 months.



Core Tier 1 capital is the standard measure of good quality capital a bank holds as a percentage of its risk-weighted assets (RWA), and the Basel III proposals hit capital ratios on two fronts: the numerator shrinks as capital is excluded, while the denominator sharply rises as the risk of many assets is considered higher.

Under the proposals unveiled in December, banks will need to exclude capital from minority interests, investments in financial subsidiaries, negative “available for sale reserves” on bond issues, pension fund gaps and other areas.

Risk-weighted assets could jump as Basel III views trading book and counterparty exposures as riskier.

Some modifications of Basel’s proposals are expected, especially the controversial proposal on how minorities are dealt with. But wholesale change is unlikely.

Barclays could need 17 billion pounds to repair an equity Tier 1 ratio that would fall to 5 percent under the proposals, Credit Suisse estimates.

The UK bank’s capital will be about 11 billion pounds lower under the new rules, largely due to the deduction of its 20 percent stake in fund manager BlackRock from common equity and deductions for minorities, deferred tax and pension fund. Meanwhile, its RWA could swell by 135-165 billion pounds, as higher risk is applied to trading assets, securitisations, counterparty credit and other exposures, Credit Suisse said.

The main comfort for banks is that with two years until the changes come into force, there is a decent transition period and some lenders have other options open.

Barclays, for instance, could halve its stake in BlackRock, and with retained earnings could generate about 20 billion pounds over the next three years, the analysts said.

Other banks face a similar period of “belt-tightening” ahead, which should limit the risk of a 2012 shock.



British and French banks are likely to be worst affected by the proposals: Credit Agricole’s core Tier 1 ratio could drop to below 5 percent by end-2012, analysts estimate; Lloyds’ ratio could fall to 4.4 percent due to the full deduction of capital from its insurance arms, according to Matrix; and HSBC’s core Tier 1 ratio may drop to 6 percent, Matrix said.

Some banks will benefit from the changes. Santander, UBS, Standard Chartered and Nordic banks such as DnB NOR and Nordea should all have excess capital under Basel III, several analysts estimated.

The Basel Committee, named for the Swiss city that has often been the site of peace negotiations, is due to publish final details by the end of this year and implement rules by the end of 2012.

A target core Tier 1 ratio has not been set, but it’s likely to be 6-8 percent. Banks that fall short will have restrictions put on pay outs, including on dividends and staff compensation.

The rules could be delayed, watered down, or subjected to “national interpretations”, and many investors and banks are counting on that.

But that could be a risky gamble.

Regulators look set to seize a rare opportunity to push through change, backed by politicians emboldened by public support to punish banks for the billions of euros of support they have received and reshape the landscape.

“No country or regulator wants to kill the banking system, but they want to send a strong message to tell banks to run their capital prudently,” said Juergen Lanzer, global specialist for financials at investment firm Schroders.

“It’s a fairly draconian message and the banks will get the message and will start to act and give more disclosure,” he said.

Matrix’s Lim added: “It will reduce the return on equity for the whole industry by a few percentage points, but the quality of that return will be a lot better.

“So it’s not necessarily bad, we should return to where banks were 20 or 30 years ago, where they were plain vanilla lenders but there’s a lot more transparency on where they derive earnings.”

(Editing by Sitaraman Shankar)

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