Paul J. Davies
After years of intense analytical work and high-level political battles, reforms to global bank capital rules are finished. And what is the upshot? Most banks already hold more than enough capital.
A small number of banks will need to cut risk or raise capital, but they have 10 years to do it. Most European banks, including those thought likely to be hardest hit—Deutsche Bank, BNP Paribas and Société Générale—saw their shares rise after the announcement late on Thursday.
Investors and many top executives will wonder whether it was worth all the bother and uncertainty.
Big European banks were the main target of the fight to tighten up the so-called Basel III capital rules, which were designed after the 2008 global financial meltdown. The Europeans’ use of sophisticated models to assess the risk of their assets undermined the credibility of the existing rules by assigning wildly different capital requirements to very similar types of loans.
These models also allowed them to support much larger balance sheets on less equity than U.S. rivals, which many in the U.S. saw as unfair. A big part of the trans-Atlantic difference is explained by Europeans holding lots of safe, prime mortgages on their balance sheets, which require less capital, while U.S. banks tend to sell those to Fannie Mae and Freddie Mac. But that hasn’t helped the perception of Europeans somehow cheating the rules.
The rule-makers have reached their goal of restricting the benefits big banks can get from using risk models. They have set their floor on how big a capital discount big banks can attain with their techniques versus unsophisticated standard models. But they only managed to do this by easing the rules a little for everyone else.
Most European banks saw their shares rise after the Basel announcement on Thursday.Photo: kai pfaffenbach/Reuters
In terms of numbers: the world’s 71 biggest banks between them are short EUR27.6 billion of common equity to meet the finalized rules if they were fully implemented today, according to the Basel Committee for Banking Supervision, which sets the rules. However, banks won’t have to begin to think about meeting them until 2022 and then won’t have to hit their targets fully until 2027.
For context, these 71 banks made pretax profits of nearly EUR200 billion in just the second half of 2015. The banks making the most profits and those most in need of capital aren’t necessarily the same ones: for example the 12 biggest Europeans are together short of EUR16.4 billion in equity. But everyone has lots of time to adjust.
In the end, politics moved on: the Trump White House focused on lightening regulation for banks, while European politicians, worried about their slow economic recovery, threatened to ignore the changes if they didn’t like them.
What really matters now is that politics doesn’t start pushing the regulatory pendulum rapidly back in the other direction. Debt levels are still very high and banks take on big risks: Another crisis is far from impossible.
Write to Paul J. Davies at email@example.com