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Banks should be prepared for 'intense regulation' post-Basel III

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Banks should be prepared for 'intense regulation' post-Basel III

The recent finalization of Basel III rules does not mean that the regulatory environment for banks will stop evolving, as a number of challenges still have to be addressed, according to industry experts.

After a long deadlock, regulators reached a compromise on risk assessment standards earlier in December, settling on a 72.5% output floor, that is, the percentage to which banks' internal risk assessment models should match the standardized model devised by regulators.

Yet announcing the new Basel III rules on Dec. 7, ECB President Mario Draghi warned: "Nothing is crisis-proof. What we should aim at is increasing the resilience of the system that we supervise. ... But where the next crisis will come from, we certainly cannot foresee."

'Intense regulation on a permanent basis'

Having flagged up "significant deficiencies" in the funding profiles "of most banks" in early 2011, S&P Global Ratings believes that the majority of them now have "adequate funding and capital positions."

But key risks remain during the Basel III implementation phase between 2022 and 2027, its credit analysts warned in a Dec. 8 report. Having reached the "high watermark" of capital regulation with Basel III, the sector is likely to see a decrease in the speed of capital accumulation in the longer term, which is a potential risk, they noted.

"Banks have to prepare for intense regulation on a permanent basis," said Christian Schiele, a partner and regulation expert at Zeb, a German management consultancy that advises financial-sector clients across Europe. The reason for that is that the new rules — despite having ensured that banks are better capitalized and more resilient — leave "a series of other unsolved challenges," mostly related to the global financial crisis, he added.

Banks also face new regulatory requirements "on a constantly high level" because regulators have to refine them due to the continued changes in the market and the need to address unresolved legacy issues, he said. As a result, regulation is always lagging behind and effective crisis prevention cannot be achieved in a sustainable manner, according to Schiele.

"One essential lesson resulting from the [financial] crisis, for example, has not been considered in the reform package so far: The interrelations between banks and governments have strongly promoted the expansion of the financial market crisis," he noted.

"Regulation continues to provide incentives for banks to hold a significant amount of government bonds — to meet liquidity requirements and through zero weighting in capital requirements calculations, among others."

This poses potential future risks as in cases of extreme indebtedness of individual countries, banks exposed to a large amount of these countries' bonds can run into trouble, too, Schiele said.

He also noted that the output-floor debate was greatly influenced by political considerations and dominated by the request that the new rules do not lead to a significant increase in capital requirements.

"The calibration of risk measurement methods should, however, not depend on political considerations, but have a sound economic foundation," he said.

The way the Basel III talks were led could be seen as a bellwether for how the rules will be implemented on a national level, indicating "a significant risk of uneven implementation of the rules", according to S&P Global Ratings.

"In our view, the difficult negotiation of these latest revisions highlights perhaps a more fragile consensus among global standard-setters and their greater comfort on the capitalization of entities in their regions," its analysts wrote.

"As a result, we also believe that, when implementing the standards domestically, local regulators may use the flexibility they have to avoid a material increase again in overall capital requirements for their respective banking systems."

S&P Global Market Intelligence and S&P Global Ratings are owned by S&P Global Inc.