This emerges from a quantitative impact study (QIS) of Basel III. Paul Hilbers, Division Director of Supervision Policy at De Nederlandsche Bank (DNB) provides insight into the challenge banks are facing. Here are his thoughts on the various aspects.
Major banks in theNetherlandsare said to be strongly capitalised, but the impact analysis still points to a greater impact on capital ratios than indicated by some analyst reports. How can this difference be explained?
I would like to emphasise that the analysis gives a snapshot of the situation at a point in time as it is based on balance sheet data of December 2009. Many analyst reports are based on more recent figures. If, at this moment, we would repeat the impact study, we would see that banks have meanwhile built up capital and liquidity buffers. This also means that shortages can be overcome: under the transitional arrangements for the implementation of Basel III, capital targets will be raised little by little until 2019. In a broader sense, banks could also take steps forward by making adjustments to their business models, such as the reduction of risk-bearing activities in their trading books.
The Netherlands does not differ all that much from the world average. How is that possible? Indeed, the core Tier 1 ratio of 5.8% for Dutch banking is only just above the international average of 5.7%. This paints a somewhat negative picture, however. For instance, specifically in the Netherlands we have seen that part of the existing capital buffer sometimes falls only just short of meeting the new quality criteria, which can be met with relatively small adjustments being made. Also, the impact study explicitly disregards that components of capital that no longer qualify for regulatory purposes will be phased out gradually. Finally, I would like to point out that compared to our European peer group, whose average core capital is only 4.9%, we perform reasonably well.
The results of the analysis point to a shortage of capital in the banking sector. What impact does this have on the economy?
A study conducted by the Basel Committee and the Financial Stability Board estimates that the worldwide shortage of core Tier 1 capital could lead to a temporary dip in Gross Domestic Product (GDP) of about one-quarter of a percent. If so, it will probably take about eight years before this effect wears off. This means that the annual growth figure is likely to be 0.03% on average lower than would otherwise be the case.
The actual impact could be even greater if, for instance, banks would try to meet the new standards earlier than required by the Basel Committee. The impact on GDP would then be slightly higher.
However, the impact on GDP could also be more limited. As said before, banks have reinforced their capital positions last year by retaining earnings and raising equity capital. This means that banks need to build up less capital in the future than has been assumed so far. Another reason could be that, in response to the stricter capital requirements, banks will try to cut operating costs, personnel costs or will shift to safer assets that are subject to less stringent capital requirements. These effects are not included in the earlier-mentioned one-quarter of a percent. This will make it less necessary to raise lending rates or to constrain lending and will thus limit the impact on the real economy.
Furthermore, the long-term benefits of a smaller likelihood – and a more limited impact – of a crisis should, of course, also be taken into account. In another study by the Basel Committee, it has been calculated that crises generate substantial losses as a percentage of GDP, which could well run into billions of euros. The IMF has estimated that financial crises can typically lead to costs that amount to 10% of national income. So it is very lucrative to try and prevent stress situations, also during the transition period. BaselIII may thus contribute to a recovery of confidence in the financial sector. DNB will therefore engage in discussions with each bank in order to map out an ambitious and, at the same time, feasible transition path. Banks should not postpone the build-up of capital and liquidity for an unnecessary length of time.
The desirability of imposing additional capital surcharges for systemically important banks has recently been subject of much debate. Are these surcharges part of theBaselIIIpackage?
Additional surcharges for systemically important banks are not part of the BaselIII package issued late last year, but are an important addition to limit systemic risks associated with large financial institutions. Both the Financial Stability Board and the Basel Committee are currently discussing the features of such an additional capital charge for systemically relevant institutions and how they could be identified.
With an average LCR of 81% and an average NSFR of 90%, the QIS results show that major Dutch banks are not yet up to the mark in terms of liquidity. Is it possible for banks to meet the new liquidity standards?
Here, too, we are talking about a snapshot of the situation in December 2009, with balance sheet changes having taken place since. Besides, the Committee has set protracted transition periods to give banks ample time for adjustments and to avoid unintended effects. The NSFR, for instance, will not come into effect as a minimum standard until 2018.
As regards the LCR, I would like to emphasise that banks are not supposed to meet this standard solely by means of raising additional liquid assets. The main purpose is that banks gradually reduce their dependence on volatile short-term funding. After all, prior to the crisis, banks had become too dependent on short-term funding, such as overnight interbank loans. The LCR provides an incentive to banks to mitigate short-term risks in their funding profiles, doing in this respect what the NSFR does with a one-year horizon.
Also, both in respect of the LCR and the NSFR, it is important to note that banks will be given ample opportunity to adapt themselves. They may, for instance, increase the maturity of their funding by motivating holders of what currently is short-term debt to invest in long-term debt. Furthermore, banks may also seek to attract long-term deposits as an additional source of financing. Finally, the capital buffers to be built up by banks under BaselIIIwill be counted as long-term funding, thus helping to narrow the NSFR gap. If any unforeseen adverse effects would arise, changes can still be made to the NSFR until mid-2016. For the LCR this is mid-2013.
The QIS results give rise to the assumption that a number of banks will have difficulty meeting the 3% leverage ratio despite the fact that, overall, the banking system meets the standards. Does this mean that the leverage ratio will have more than a backstop function?
The leverage ratio of banks will, on average, be above 3%, but a number of banks will not be able to reach that level. Here, too, the QIS results are based on banking data as at year-end 2009, and banks have meanwhile built up more capital. Capital that they are also building up in order to meet the higher risk-weighted capital requirements. In addition, it should be taken into account that the leverage ratio will be phased in only gradually. This means that until 2017 a parallel run will take place in which to assess whether the leverage ratio has an adverse effect on niche business models and whether the leverage ratio, in its present form, interacts as it should with the risk-weighted capital requirements. Insofar as a bank’s risk measurement system is sufficiently comprehensive and forward-looking, the risk-weighted standard remains the most important supervisory benchmark. Incidentally, it will not be until January 2018 that the leverage ratio – with possible adjustments made to it – will be a strict requirement. From January 2015, banks must publicly disclose their leverage ratios.
As can be gathered from theBaseldocuments published at the end of last year, rapid credit growth would have caused the countercyclical buffer to be deployed in theNetherlandsover the last few years. Does this mean that Dutch banks should reckon with an add-on of up to 2.5%?
That is difficult to say. Important is, at any rate, that banks themselves should pay special attention to macroeconomic imbalances. For instance, to the credit/GDP indicator – the starting reference point for deployment of the countercyclical buffer – as well as to other relevant indicators such as credit spreads and house price developments. After all, the authorities also take account of these factors in their final buffer determination. Furthermore, I would like to emphasise that the countercyclical buffer need only to be phased in from 2016 and it is conceivable that in the meantime, due to currently moderate credit growth, the countercyclical buffer returns to zero.
