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13 April 2017

Bloomberg: European banks may face $128 billion capital gap as Basel bites

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European banks may have to plug a capital shortfall of 120 billion euros if new regulations drawn up by regulators including the Basel Committee on Banking Supervision come into force as they stand, according to McKinsey & Co.

The committee is putting the final touches to the Basel III post-crisis capital rules, setting stricter standards for how lenders estimate the riskiness of their assets. The global banking industry has dubbed this Basel IV, arguing that it constitutes a new, separate round of regulation. European resistance to aspects of the rules has stymied efforts to meet an end-2016 deadline to complete the process, which has now stalled.

“This is a game changer for the European banking industry,” McKinsey said in the report. “Banks will need to raise more capital, and will likely have to take some unconventional measures to comply” with the new regulations, it said.

The new standards from Basel, as well as a new accounting framework that will govern how banks provision for bad loans, will reduce European lenders’ common equity Tier 1 ratio, a key measure of financial strength, by 3.9 percentage points to 9.5 percent in aggregate, the report said, based on figures as of mid-2016. This would leave banks short of the estimated 10.4 percent ratio regulators require, it said. Under the same assumptions, capital ratios of their U.S. counterparts would fall by 1.3 percentage points.

The main driver of higher capital requirements is a so-called output floor, a rule that acts as a blunt check on how much lower banks’ own estimates of asset risk can be, compared with those produced by standard formulas set by regulators. That alone would trim CET1 ratios by 1.3 percentage points if introduced as proposed in a compromise put forward in December, McKinsey said. Changes to the operational-risk framework would cost banks 0.8 percentage point.

The study also incorporates the effect of planned rules that cover how much capital banks use to fund the stocks, bonds, derivatives and other assets they have in their trading businesses. The so-called Fundamental Review of the Trading Book was finished on a global level in early 2016 and is currently being transposed into European Union law.

The report also calculates the effect of IFRS 9, new accounting standards that will change the way banks provision for loan losses. In Europe, the rules are scheduled to come in from next year.

If all the rules come in as currently expected, the greatest impact will be felt by banks in Sweden, Denmark, Belgium, the Netherlands and Ireland, McKinsey said. Particularly in the Nordic countries and the Netherlands, banks calculate their capital needs using traditionally low default rates on their mortgage portfolios. An output floor would limit the scope for that, driving up capital requirements, according to the report.

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