ANALYSIS-Implementation key to Basel III success

By Reuters Staff
September 13, 2010

By Huw Jones

LONDON, Sept 12 (Reuters) – The global “Basel III” deal on bank capital standards was reached at lightning speed by usually glacial regulators — substantive negotiations took about a year, compared to a decade for the current Basel II rules.

But implementing the new standards consistently over the lengthy phase-in period will be a headache for national regulators, and determine whether Basel III succeeds better than its predecessor in reducing bank sector risk.

* The Basel III rules are much tougher than Basel II, which failed to ensure banks held enough capital to withstand the worst financial crisis since the Great Depression.

* Although Basel III more than triples the amount of top-quality capital that banks will have to hold in reserve, there are several potential pitfalls in timing and content that could undermine the reform’s effectiveness.

* The key aspects of the completed package will not all be phased in until the start of 2019, presenting a challenge for supervisors and their political masters to maintain momentum in their supervision of the sector. Lobbying by banks or an eventual return to boom times could blunt the will to enforce Basel III, as memories of the global credit crisis fade.

* The new capital conservation buffer of 2.5 percent, which is lower than some banks had feared, will not be fully in place until the start of 2019. At this time, the buffer plus the Tier 1 capital requirement will total 7 percent; in practice this is likely to become a solid floor for banks, because they will not want to face curbs on payouts such as bonuses, dividends and share buybacks. Falling below 7 percent could damage a bank’s reputation among investors and in the money markets.

* The new capital rules are not the only fresh burden on banks; they should be seen in conjunction with a range of regulatory initiatives that together could have large and unpredictable effects on banks.

Banks will have to comply with the first new global liquidity standard from January 2015; this will increase pressure to build up reserves of cash-like assets.

Separately, regulators will introduce far tougher capital requirements on bank trading books from the end of 2011, and these will force some institutions to rethink whether they want to continue financial market trading.

Also, national regulators may still impose other surcharges on big, systemically important banks as they grapple with the “too big to fail” problem; this prospect could cause large banks to build up more capital than the Basel III rules, taken in isolation, appear to imply.

* But there are doubts about how effective the new countercyclical buffer will be, if and when it kicks in.

“You have a bald number to protect against excess credit but bubbles tend to affect individual asset classes at different points in time so it’s a blunt instrument. To manage risk you have to be more targetted,” said Richard Barfield, director at PriceWaterhouseCoopers.

It will be up to each national supervisor to determine when banks on its turf should start building up a countercyclical buffer; in the past, this has been a recipe for widely different approaches by regulators.

* Implementation is likely to be more universal than it was under Basel II; this time the United States appears fully on board, after it failed to implement all of Basel II. However, the lengthy transition period means political and economic changes may have altered the intentions of U.S. regulators by the time compliance becomes mandatory.

* Some top banks already hold more high-quality capital than Basel III will require. But many banks may feel pressure to show investors they can comply with the new package sooner rather than later, in order to ensure they are not be lumped in with the stragglers in raising capital.

“I expect that what will happen is that the larger banks will move towards these figures ahead of the timetable,” said Barfield at PricewaterhouseCoopers.

* There are still controversial loose ends for regulators to tie up to make the Basel III package fully effective.

The announcement of full details of a planned cap on leverage and new liquidity requirements were delayed in July this year; their implementation is not due until 2018 once full details have been fleshed out, which will not be easy.

* The consensus on Basel III could start to fall apart if unforeseen impacts or foot-dragging by some countries starts to give banks in certain places competitive advantages over peers elsewhere.

“There has been a tremendous focus on getting this done quickly and it has been done to the G20 timeframe, which is why we need this ongoing monitoring and ability for mid-course corrections,” said Simon Hills, a director at the British Bankers’ Association.

* Basel III is at the core of the G20′s efforts to apply lessons from the global financial crisis, and Sunday’s agreement will allow G20 leaders meeting in Seoul in November to congratulate themselves by endorsing a major reform of banks.

But there is a risk that the G20 could put too much reliance on higher bank capital levels and not focus enough on strengthening other aspects of the financial system that were found wanting in the crisis.

“Apart from a consistent worldwide application, it’s important that capital is just part of the process of improving financial stability. The other key factors are improved supervision, improved risk management and making those things happen as well is the difficult challenge,” Barfield said. (Editing by Andrew Torchia) ((huw.jones@thomsonreuters.com; + 44 207 542 3326))

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