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Away from the media glare on the ongoing sovereign debt nightmares in Europe, European Union finance ministers have been steadfastly hammering out legislation to complete the implementation process for the Basel III accords, which will govern banking capital and liquidity levels at banks for years to come.
The latest version of the Basel accords will have a major impact upon US-based global institutions such as Bank of America, BNY Mellon, Citigroup, Goldman Sachs, JPMorgan Chase & Co., Morgan Stanley, State Street, and Wells Fargo. Most of these players would probably prefer to avoid another set of new regulations. In fact, many US firms have managed to sidestep the Basel II and II.5 rules. But those days are over. The tougher rules of Basel III will impact key players as Fitch Ratings has highlighted today in its report “Basel III: Return and Deleveraging Pressures.”
Fitch Ratings estimates that 29 global systemically important financial institutions (G-SIFI) need to raise “$566 billion in common equity to satisfy new Basel III capital rules by end-2018.” Among other problems, the Basel III requirements could have a chilling effect upon buybacks and dividend increases from these firms, says Fitch Ratings.
“The $566 billion figure represents a 23% increase relative to these institutions’ aggregate common equity of $2.5 trillion,” according to Fitch Ratings. “Once fully implemented, the stricter Basel III capital rules could imply an estimated reduction of more than 20% in large banks’ median return on equity (ROE), from about 11% over the past few years to approximately 8%-9% under the new regime. For banks that continue to pursue mid-teen ROE targets (e.g. 12%-15%), Basel III creates potential incentives to reduce expenses further and to increase pricing on borrowers and customers where feasible.”
Full Basel III implementation is slated for 2018, but Fitch Ratings suggests that global banks will have “both market and supervisory pressures to meet these targets earlier.” The phase-in for Basel III begins next year.
In addition to the ROE impacts, Basel III will bring several operational and IT challenges that Wolters Kluwer Financial Services has specified in a new position paper, “Implementing Basel III—Are You Ready?”
For starters, Wolters Kluwer asks firms to think about how they will manage the data challenges to come via Basel III. Not surprisingly, firms will need centralized data systems and “timely and accurate data out of myriad systems in order to get a single view of the enterprise,” in order to get a better grip on their positions, according to the paper. The greater transparency requirements of Basel III will also mean “more automated and robust reconciliation procedures.” The paper also urges firms to have “realistic but challenging scenarios for stress testing and reverse stress testing,” a realignment of business models such as the de-risking of lending activities, and standardized reporting across all branches.
But, before banks revamp operations and adopt Basel III toolsets, they need to create “an evolutionary path” to new risk management capabilities to meet the demands of more risk types and capital buffers, noted market research firm Celent in a report “Basel III: Navigating Business and Risk Technology Architecture Decisions,” released about six months ago. “As firms navigate this regulatory chessboard of options and rules, they need to bear in mind business and risk management imperatives, as well as avoid being ‘too far behind’ in their IT strategy and architectural considerations,” according to Celent.
Unlike those working behind the scenes to resolve the debt crisis in Greece, the EU finance ministers have found a way to reach agreement on the rules of the road for Basel III. This new consensus will usher in a new era, but the protections Basel III offers will yield mixed blessings for those firms that have to implement them.
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