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Fitch attempts to tally the cost of Basel III
FT Alphaville blog post

So you’re a global systemically important financial institution and, bar a few near global meltdowns, you have a pretty good time of it… but you also know Basel III is fast coming down the tracks and in its attempt to make you better able to stand up to those unexpected shocks that nobody likes, it will force a load of restraining rules upon you.

Fitch has gamely joined the ranks of those trying to put some numbers on the whole thing. The ratings agency had a look at the 29 global systemically important financial institutions (or G-SIFIs, a horrible acronym for banks listed at the bottom of this post), which as a group represent $47tn in total assets, and estimated that they might need to raise roughly $566bn in common equity in order to satisfy the new Basel III capital rules:

Fitch argues (our emphasis):

This potential capital increase would imply an estimated reduction of more than 20% in these banks’ median return on equity (ROE) from about 11% (over the past several years) to approximately 8%–9% under the new regime. Basel III thus creates a tradeoff for financial institutions between declining ROE, which might reduce their ability to attract capital, versus stronger capitalization and lower risk premiums, which benefits investors.

The G-Sifis are being especially hard hit as they will be subject to higher capital requirements than other banks under Basel III – reflecting their significance to the global economy

G-Sifis will have to stump up an additional Tier 1 common equity buffer of between 1 and 2.5 percentage points, depending on the systemic importance of the particular institution making the potential minimum required Tier 1 common equity ratio 9.5 per cent.

So Fitch assumed that each G-SIFI will hold a projected Basel III Tier 1 common equity ratio of 10 per cent, which included a discretionary 1 per cent buffer.

(If Fitch had assumed a 9 per cent ratio the banks would have faced a shortfall of $342bn instead.)

The 10 per cent ratio assumed would, says Fitch, represent a 23 per cent increase relative to the bank’s aggregate common equity of $2.5tn with the median bank needing some $18bn (and some large differences across the regions):

And that will force those banks into a variety of measures to cut that gap including retention of future earnings, equity issuance, and reducing risk-weighted assets (which will be much harder hit under Basel III as the second chart down shows). *Warning: even broader estimates ahead*

So, the G-Sifis will be deleveraging as they prepare for Basel III to hit (which it will do by the end of 2018, although many banks will not wait that long) and as banks start to avoid riskier assets and the higher capital charges they bring with them.

Fitch argues there will thus be an increase in general borrowing costs, diminished availability of credit, reduced asset liquidity liquidity, a shift to securitization and capital markets funding or migration to less regulated segments of the financial system.

Which essentially means the banks won’t take this lying down and will adapt… which is nice, as we were worried we would have nothing left to do.

Finally, we present your G-Sifis:

And note we put the full report (which includes a handy Basel II versus Basel III comparison chart for you to print off and hang on your wall) in the usual place.

This entry was posted by David Keohane on Thursday, May 17th, 2012 at 9:00 and is filed under Capital markets. Tagged with Basel III, Fitch Ratings, systemic risk.