Basel III A more resilient banking sector or mere cost

The final framework for Basel III accord released by the Basel committee in June 2011 lays down the guidelines for the next phase of banking reforms. It lays emphasis on better quality capital, more liquidity and thus lesser systematic risk in the banking sector. The broad changes include increased emphasis on the quality of capital, introduction of newer ratio like liquidity coverage ratio (LCR), net stable funding ratio (NSFR) and additional capital charge for counterparty risks on derivatives in the form of credit value adjustment (CVA). Ratios like LCR and NSFR have led to banks vying for retail deposits and longer term funding options, even at a greater cost. CVA is impacting the way banks look at their derivatives portfolio, something the global banks have relied on for high profitability. The changes to the definition debt instruments which qualify for Tier I & Tier II capital is leading to a shortage of capital amongst banks and a rush to shore up capital by issuing new instruments which qualify the new definition. The Basel III accord mandates that these instruments necessarily need to have a conditionality clause which would enable the loan to be written off or get converted into equity in cases where the local regulator declares the bank to be non-viable or stressed, without causing a default event. The introduction of th is additional clause in the bond conditions results in an increase in cost of borrowing. Of recent, there have been a number of banks trying to unsuccessfully place these Basel III bonds at low yields that they have previously been used to. This is a clear indication by the market that these bonds with their conversion feature call for a significantly higher premium. The increase in cost of borrowing and additional capital requirements are leading to a significantly lower return on equity than the investors are traditionally used to. The regulators including the Basel committee argue that traditional banking should not have the high return on equity that was experienced in the previous years, and though the return decreases so does the risk and the returns are less volatile. A large part of the banking community, especially in countries outside of USA and Europe where the banks have been relatively stable, feel that they are being made to pay for others sins. www.eduleap.in