The latest global financial reform milestone may come this Sunday, when global bank regulators vote on "Basel III."
Basel III aims to discourage global banks from taking "excessive risks" by chiefly tightening capital and liquidity requirements, but the exact details won't be released until Sunday.
It's unlikely Basel III will be overly severe and a preliminary "Basel III" agreement released in July was already watered-down from proposals made last December.
Settling on the terms of Basel III will give banks a clearer picture of the future regulatory landscape, possibly giving them greater comfort to lend hoarded capital.
2008's financial crisis may have subsided in 2009, but global banking regulators are still finalizing financial reform more than halfway into 2010. The latest major milestone may come this Sunday, when the oversight body of the Basel Committee is expected to approve revisions to international banking standards dubbed "Basel III," paving the way for its final approval by the G-20 nations in November.
The Basel Committee, comprised of central bankers and bank regulators from developed and emerging markets, is tasked with establishing minimum, uniform capital standards and controls for cross-border banks. Basel III is the latest iteration of those international standards—and a direct response to 2008's crisis.
Though the reforms' intentions are clear—they aim to discourage global banks from taking "excessive risks" by chiefly tightening capital and liquidity requirements—the exact details won't be released until Sunday's meeting, fomenting speculation as to their final form. The uncertainty surrounding the details may have added to Tuesday's investor skittishness about European bank stress tests.
Rumors circulating this week included speculation Basel III may require banks to hold higher Tier 1 capital ratios (Tier 1 capital—mostly common equity and retained earnings—divided by risk-weighted assets) anywhere from a minimum of 9% including a 3% "capital conservation buffer" (a constant cushion of excess capital above regulatory minimums) to 6% with a 2% buffer—raising the current 4% Tier 1 capital requirement. There were also talks about higher core capital requirements, definitions of accepted capital, and the length of time banks will have to comply with the new rules.
Understandably, Basel III has stirred concerns in the international banking community since initial proposals were first announced last December. Too stringent standards might cause another round of capital raising activity that could dilute bank earnings. However, it's unlikely Basel III will be overly severe since consensus agreements in international bodies are typically wrangled through compromise. A preliminary Basel III agreement released in July was already watered-down from the December proposals.
Plus, this week's rumored capital ratio requirements aren't too far off expectations, especially considering US banks already have a 6% minimum Tier 1 capital ratio requirement but hold over 12% on average according to a recent FDIC report—possibly bracing for strict Basel III requirements. Additionally, the EU bank stress tests also assumed 6% as its baseline ratio and banks mostly passed with flying colors. Moreover, European banks repaid €443 billion of European Central Bank (ECB) loans without a hitch in July, and demand for recent ECB liquidity has been tepid—a strong indication European banks have ample capital.
Basel III isn't coming as a surprise to global banks—it's been in the works awhile. And new capital requirements will likely have a lengthy phase-in period. Like the passage of financial reform in the US, settling on the terms of Basel III will give international banks a clearer picture of the future regulatory landscape, possibly giving them greater comfort to lend hoarded capital—a plus for the global economy.