12 September 2013

Capital requirements could rise as 'Basel 4' starts to emerge, says KPMG

Regulators around the world – and the banks themselves – have fast-tracked the implementation of Basel 3 as a safeguard against another financial crisis, raising the capital levels that banks must hold.  But there are strong signals that we are already moving beyond this to the emergence of the next iteration of the capital standards framework, or ‘Basel 4’.

This is evidenced by:

• The gold-plated implementation of Basel 3 in some countries, including the US and UK
• Some countries already moving beyond Basel 3 by requiring banks to hold capital buffers to absorb the impact of stress tests, over and above the Basel 3 minimum capital standards, and setting a minimum leverage ratio above 3 per cent
• Widespread concerns among regulators and market analysts about banks’ internal modelling and the accuracy of the resulting risk weighted assets
• A flurry of papers in the last couple of months from the Basel Committee that look beyond Basel 3
• For euro bank areas, the prospective actions of the European Central Bank as supervisor, regulator and macro-prudential authority 

Giles Williams, partner in Financial Services at KPMG, said: “The pace of change and the desire by regulators to safeguard financial stability at all costs means that the regulatory timetable is getting far ahead of itself. The outlines of ‘Basel 4’ are already becoming visible, five years before the technical implementation deadline for Basel 3. Care needs to be taken that the banks are not being asked to do too much too soon.”

Recent developments are likely to result in three changes that might form the basis of ‘Basel 4’: 

• Requiring banks to meet a higher minimum leverage ratio
• Restricting the advantages to banks of using internal models to calculate their capital requirements
• Significant disclosure by banks

If we maintain the same asset base, KPMG calculates that the higher capital requirements could equate to an additional £50 billion that the UK’s largest eight banks would need to hold – on top of the £260 billion they already need to set aside under Basel 3. In market conditions that are still challenging and uncertain, there would be a serious question whether this amount was available, and if not whether deleveraging would be the only logical response.

Giles Williams said: “We caution against an over-zealous pursuit of simplicity. An over-reliance on standardised risk weightings or a non-risk sensitive leverage ratio could have perverse consequences. It could encourage banks to hold relatively more riskier assets and could increase significantly the cost of funding a portfolio of lower risk-weighted assets, such as mortgages. 

“It is important to take account of the linkages between the Basel 3 minimum capital and liquidity requirements and the additional demands on these scarce resources arising from the multiple regulatory reform initiatives running in parallel to Basel 3. The Governor of the Bank of England’s recent speech recognised this conundrum, and was welcome.”

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