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How Basel III will affect banks

19 February 2013 Fiona Zerbst
Fiona Zerbst, FAnews Online Editor

Fiona Zerbst, FAnews Online Editor

Basel III rules were introduced following the 2008 financial crisis which hit the US and spread from there. A crisis of confidence in banks followed, which made regulators wary, leading to the Basel Committee on Banking Supervision (BCBS) looking at how e

In terms of the Liquidity Coverage Ratio (LCR), banks need to consider what might happen in a crisis situation, when there is a net cash outflow from a bank. They need to ask if they have enough high quality liquid assets to weather the storm.

Four key changes

The BCBS has recently made four key changes here, in recognition of the “implications of the standard for financial markets, credit extension and economic growth … and at a time when there is ongoing strains in some banking systems”.

First, the range of eligible assets has been extended – it was previously narrow and strict.

Secondly, it has relaxed some of the assumptions about how to estimate the net cash outflow.

Thirdly, banks will now only need to comply fully with the LCR by 2019 (previously, the deadline was 2015) and the requirement will be phased in, starting with 60% then increasing to 70% and so on – so, for example, if you expect R100m net cash outflow in a year you need to hold only R60m of liquid assets according to the 60% allowance.

Finally, in times of stress, the regulator will allow banks to use the stock of liquid assets they have accumulated, which means they will no longer be required to hold 100% at all times.

It’s also worth noting that the SA Reserve Bank has made a liquidity facility available, which goes some way towards assisting banks to meet this LCR. This is based on bank contributions and would cover up to 40% of a bank’s liquidity requirement if there were to be a banking crisis. The ratio holds that banks need to hold enough liquid assets to be converted into cash in 30 days, which is fairly stringent.

The net stable funding ratio challenge

The net stable funding ratio presents quite a different problem, however.

The net stable funding ratio (NSFR) forces banks to diversify their funding structure so that they have more long-term, stable funding on their books. Our banks however mainly use short-term, wholesale funding to fund some long-term products, like mortgage loans. So this particular ratio is likely to cause headaches for banks as they strive to meet Basel III requirements.

It’s likely that the NSFR will still go through a number of changes, says PwC’s banking and capital markets leader Johannes Grosskopf.

On the funding side, longer-term funding costs more than short-term funding; this will obviously have an impact on price, as the cost of lending increases. However, it is not necessary that the higher funding costs will be passed fully on to the economy as it is possible that capital and fund providers may demand lower returns on their investments given a more resilient banking system, both from a liquidity and a capital perspective.

The effect on money markets

According to Stanlib bonds trader Ian Scott, Basel III will prejudice the systemic relationship between our banks and money-market funds. Money-market funds buy up significant amounts of bank debt but wouldn’t meet Basel III requirements as they don’t qualify as stable funding, given their ‘wholesale’ classification. These funds are currently 85% exposed to banks and banking balance sheets are probably funded by money markets to the tune of about 25%-30%, says Scott.

In essence, banks are not incentivised to pay good rates to money-market funds because they do not qualify as long-term stable funding. Banks are not taking the money-market deposits of asset managers and are forcing them to look at alternative options, like short-term commercial paper.

Grosskopf explains that when customers place money with a money-market fund, the fund in turn invest such money in liquid bank paper. This deposit by the fund is classified as a wholesale deposit, not a customer deposit, which does not qualify as long term stable funding to the same extent that a normal customer deposit would have.

Scott says the banking regulator will need to revisit how it looks at money-market funds because if banks can’t access cheaper, bulk funding from money markets they will have to entice us with higher rates and it will cost more to get deposits into the banking system. Does the consumer know they will have to pay more so we can comply with Basel III? Banks will either have to find expensive, longer-dated wholesale funding in global markets, or increase their ratio of longer-termed retail deposits.

Although Basel III applies to banks globally, Scott feels that it places an unfair burden on our closed Rand system, where banks and money-market funds are so closely aligned. He feels clients will need to move into income funds to make a higher return. And banks will fork out to attract customers to invest in retail deposits because they will have to pay these investors higher interest rates, which cost they will pass on to customers lending money for home loans, vehicles, overdrafts and so on.

Editor’s thoughts: It seems likely that Basel III requirements will be significantly watered down, so perhaps some of these issues will be resolved by the BCBS itself. Final amendments to the NSFR are expected in mid-2016, so banks do have time to adjust. However, we are still some way behind European banks in terms of meeting the NSFR requirement, which is a concern. What do you think of Basel III requirements? Add your comment below or email [email protected]

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