You are on page 1of 6

Basel III Implications for financial institutions and consumers

Basil III
Implications for
financial
institutions and
consumers

May 7

Basel III Implications for financial institutions and consumers

Contents
Introduction................................................................................................................ 2
Rationale for Basel-III.................................................................................................. 2
Impacts of Basel-III..................................................................................................... 2
Impact on financial institutions...............................................................................2
Impact on consumers.............................................................................................. 3
Conclusion.................................................................................................................. 4
References.................................................................................................................. 4

Basel III Implications for financial institutions and consumers

Introduction
Basel-III refers to a comprehensive set of measures taken by the Basel committee on banking supervision
so as to bring about better supervision and risk management within the financial sector of Europe. The
reforms aims to attain various objectives with respect to improving the governance mechanism in the
banking sector, improving the ability of financial institutions to absorb economic stress and to build about
better disclosure and transparency.

Rationale for Basel-III


The rationale behind framing the Basel-III norms was to be bring about an enhanced level of dynamism,
complexity, and interdependency in the regulatory space for financial institutions. Basel-III attempts to
fill the gaps prevalent in the previous Basel-II system. Basel-III requires higher risk weights for assets
which are more risky. It prescribes a higher regulatory capital requirement for financial institutions, and
proposed steps towards better management of liquidity as compared to Basel-II arrangement. The primary
need for implementing Basel-III norms arose from the 2008 European crisis where the sub-prime lending
business was adversely impacted. Excessive leverage and exposure to risky assets made it tough time for
banking institutions to raise capital when they needed the most, as shown in figure 1 below. The exact
need for better capital and liquidity management gave rise to the Basel-III norms.

Figure 1: Sub-prime crisis of 2008 and the need for Basel-III norms (infosys.com, 2013)

Basel III Implications for financial institutions and consumers

Impacts of Basel-III
Impact on financial institutions
Basel-III norms had significant impact on the financial institutions in general. Introduction of new forms
of liquidity ratios made the firms focus more on long term funding arrangements and this in turn impacted
the margins and pricing too. However, the arrangement for enhanced liquidity buffer improved the risk
management standards of financial institutions and reduced the immense interdependency which was
existing prior to Basel-III. Another crucial impact is that banks now hold a greater Capital conservation
buffer of 2.5% (KPMG, 2011). This eventually increased the capacity of banks to absorb losses during
periods of financial crisis. Additionally, a new kind of buffer called as countercyclical buffer was
introduced in Basel-III. This buffer would help slow banking activity if it overheats, and encourage more
lending as soon as banking system slows.
The Basel-III norms have a put a cap on the leverage ratio. This is the ratio of the relative amount of
capital to total assets. The 2008 financial crisis was a direct outcome of assets value falling quicker than
assumed. Thus, leverage ratio would now act as a safety net (Allen, et al., 2012). The banks would now
face a growing pressure to sell off low-margin assets and focus more on high returns instead of
undertaking random mortgages as per the earlier system. Similarly, the Basel-III norms have also raised
the requirement of common equity from 2% to 4.5%. This common equity is generally regarded as the
most powerful form of loss-absorbing capital. Similarly, other tier 1 capital requirements have also
increased from a minimum of 4% to 6% (McKinsey, 2010). This again increases the cushion for banking
and other financial institutions. Added to this, Basel-III norms have introduced the concept of Net Stable
Funding ratio (NSFR), the purpose of which is to give incentives to banks to apply stable sources for
funding their activities. For banks, this will lead to increase in stability of funding mix as it decreases
reliance on short-term funding. To some extent, funding costs for banks might increase as they try to raise
the proportion of deposits with maturities greater than one year.
Thus, overall the changes have resulted in better quality as well as quantity of capital with financial
institutions. It has led to increased and stable long-term balance sheet funding and better short term
liquidity coverage for firms.

Impact on consumers
The Basel-III norms had a number of crucial impacts on the banking customers, from the perspective of
overall demand for credit. It can be analyzed that imposing higher capital ratios on banks require that
these institutions raise more capital. This tends to put upward pressure on the cost of capital, which
3

Basel III Implications for financial institutions and consumers


eventually banks add to their lending rate. This would reduce both consumer spending as well as
investments. In this context, monetary policies would have to play a crucial role in easing this impact, for
example: by lowering current overnight rates etc. (McKinsey, 2010). This can ensure that credit demand
is not much impacted. Similarly, when banks face more competition in the loan market, then higher
funding costs would start putting pressure on the banking system resources. Intermediation in the form of
favorable monetary policies would mean that cost of credit for customers of bank would fall. In other
words, by ensuring that public sector subsidy to risk-taking is reduced, banking customers can be
benefitted.
Some amount of impact can also be noticed in the corporate banking segment where most of the standard
corporate banking products got impacted due to increased capital target ratios. Most long-term asset based
finance businesses faced an increased funding cost of over 10 basis points. Given the fact that banks
could not pass on these cost increases eventually leading to less capital available for small corporate
customers.

Conclusion
Thus, the Basel-III reforms brought about a major change in the capital adequacy guidelines. Overall, the
reforms can be categorized as capital reforms, liquidity standard reforms and the reforms towards
systematic risk management. For financial institutions, the reforms provided and platform for better
absorption of a crisis similar to the 2008 financial turmoil, by means of building a high quality, consistent
and transparent capital base. It helped institutions to capture all risks, control leverages and create better
buffers. By creating a stable funding ratio, it created more opportunities for long term customers.
However, it also increased the role of monetary policies within the economy with respect to sustaining
credit demand and investment promotion for small and medium scale investors.

References
Allen, B., Chan, K., Milne, A. & Thomas, S., 2012. Basel III: Is the cure worse than the
disease?. International Review of Financial Analysis, pp. 159-166.
infosys.com, 2013. Basel-II to Basel-III - The way forward. [Online]
Available at: https://www.infosys.com/industries/financial-services/whitepapers/Documents/base-way-forward.pdf
[Accessed 7 May 2016].
KPMG, 2011. Basel III: Issues and implications, s.l.: KPMG.
4

Basel III Implications for financial institutions and consumers


McKinsey, 2010. Basel III and European banking: Its impact, how banks might
respond, and the challenges of implementation, s.l.: McKinsey and Co.