13 September 2024
This week saw significant developments in banking regulation as the Federal Reserve and the UK’s Prudential Regulation Authority revised their capital requirements under the Basel III reforms respectively. In the US, large banks are now required to increase their capital by 9%, down from the previously proposed 19%, following pressure from the banking industry. Similarly, the UK has delayed the implementation of Basel 3.1 by six months and introduced lower capital requirements for SMEs, trade finance, and infrastructure lending. While these revisions are seen as a win for lenders, they may complicate matters for banks operating across multiple jurisdictions and lead to real world impact.
The reduction in proposed capital requirements represents a notable concession to the banking industry. While the easing of these requirements might seem like a win for financial institutions, it is essential to understand the broader implications of this adjustment.
Even with the softened requirements, there is still an overarching push towards tighter capital and Risk-Weighted Assets (RWA) standards. This adjustment will necessitate improvements in banks’ risk modelling and data management processes. These reforms aim to enhance financial stability but come with a set of complex consequences that need careful consideration.
One of the immediate impacts of these reforms will be on lending costs. As banks adjust to the higher cost of capital—capital being significantly more expensive than debt—these costs will inevitably be passed on to households, businesses, and clients. This could lead to higher borrowing costs and strain various sectors of the economy, potentially driving up the price of credit and financial services.
Furthermore, the adjusted capital requirements could spur a surge in shadow banking, as institutions seek alternative avenues to remain competitive. The redefined regulatory landscape might push banks into riskier markets or encourage more opaque financial practices, which could have far-reaching effects on the stability of the financial system.
With these impending reforms, financial institutions will be considering a number of points, including:
This includes transforming vast amounts of counterparty trade data into actionable insights and refining their trading agreements.
Unlocking the value embedded in legacy trade agreements and optimising data that feeds into internal risk models could be crucial for banks to maintain their competitive edge. It’s not just about regulatory compliance; it’s about leveraging every available resource to maximise “share of wallet.”
An intriguing aspect of the recent regulatory changes is the increasing politicisation of financial oversight. The Federal Reserve’s decision to lower the Tier 1 capital requirements reflects broader political dynamics, particularly as the US braces for an upcoming election. Similarly, the Bank of England’s move to reduce capital requirements aligns with the Labour government’s focus on boosting small businesses and housing construction.
This intertwining of politics and financial regulation raises questions about the true independence of regulatory bodies. While these institutions are designed to operate without political interference, their actions often reflect the prevailing political climate and priorities.
The Basel III reforms aim to balance financial stability with the needs of the banking sector. While relaxed capital requirements may ease pressure on banks, they also bring new risks and challenges. Financial institutions will need to navigate compliance, risk management, and strategy in this evolving landscape.
At Likezero, we are committed to helping our clients navigate these regulatory hurdles. Despite the significant changes in trading regulations, the contracts that underpin these relationships—many dating back to the 80s and 90s—remain largely unchanged, adding another layer of complexity to the evolving market.
Michael Lines, Likezero’s CEO, shared his insights with The Banker on this topic. Read the article here.
