New capital requirements under the Basel III framework would have cost banks roughly $770 billion had they been fully implemented at the end of last year, according to a 32-page study released Thursday by the Basel Committee on Banking Supervision.
The study also said that the shortfall for larger banks considered to be well-diversified and internationally active was far greater than for smaller institutions when it came to meeting new capital, leverage and liquidity ratios.
The report by Basel was unveiled along with the official text of the new rules, which call for stronger capital requirements, better risk coverage and introduces an international leverage ratio. The agreement was signed off by leaders of the Group of 20 nations in Korea in November.
"The Basel III capital and liquidity standards will gradually raise the level of high-quality capital in the banking system, increase liquidity buffers and reduce unstable funding structures," said Nout Wellnick, chairman of the Basel Committee, in a press release. "The transition period provides banks with ample time to move to the new standards in a manner consistent with a sound economic recovery, while raising the safeguards in the system against economic or financial shocks."
In an effort to assess the impact of the new requirements under Basel III, including the Tier 1 common equity standard, capital conservation buffer, and two international liquidity standards — the liquidity coverage ratio and the net stable funding ratio — the panel conducted a quantitative impact study.
In total, 263 banks from 23 member countries participated in the study, which were divided into two tiers. Group 1, which included 94 banks, held Tier 1 capital in excess of $4 billion and were considered well-diversified and internationally active. The remaining 169 banks fell into Group 2, which were all other banks.
The panel said the report did not take into account any transitional arrangements such as a phase-in of deductions and grandfathering arrangements. The results also assumed full implementation of the final Basel III package based on data at the end of 2009.
For example, implementing the new risk-based capital requirements for banks in Group 1 resulted in an average 5.7% ratio, a drop from the 11.1% ratio reported last year. For Group 2, average declines were considerably less with ratios falling to 7.8% from 10.7%.
Under the new Basel III standards, banks will have to hold a 7% Tier 1 common equity threshold by 2019. According to the study, banks in Group 1 were $737 billion short of such a standard at the end of last year, while banks in Group 2 were $33 billion short.
The Basel Committee noted that since 2009, banks have continued to raise their common equity capital levels through equity issuance and profit retention. The new standard will be phased in gradually. Banks have until 2015 to ensure their common equity reaches a 4.5% minimum ratio, and 2019 to meet the additional 2.5% conservation buffer standard.
Additionally, the panel studied the impact of new liquidity standards on the banks. Assuming banks made no changes to their liquidity risk profile as of the end of 2009, the average liquidity coverage ratio, which is intended to provide short-term resilience for a 30-day period, was 83% for Group 1 banks, while it was 98% for the rest.
The net stable funding ratio, which provides longer term funding for at least a one-year period, stood at 93% for Group 1 banks, and at 103% for all other banks.
Banks have until 2015 to comply with the liquidity coverage ratio, and 2018 to meet the net stable funding ratio. Both are required to be at least 100% to meet the standards.
The panel suggested that banks with shortfalls could meet those standards by lengthening the term of their funding or restructuring business models.
Separately, the committee introduced transition periods to help meet the new liquidity requirements.
It also said it would monitor the standards during an observation period and continue to review the impact the new standards have on financial markets, credit extension and economic growth.
The Basel panel also published guidelines on countercyclical capital buffers, which is intended to bolster capital during credit booms to ensure they are well capitalized in the event of a market crash. Such buffers will be implemented by countries at the national level since business cycles differ on a country-to-country basis, the panel said.
This story has been reprinted with permission from American Banker.
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Corrected December 16, 2010 at 11:31AM: yes