Home | Topics | Basel III

Basel III Is Just the Beginning

Printer-friendly versionPDF version

There’s a widespread view the 2008 banking crisis is over. It’s not. At least not in Europe. And the eventual fallout could result in a significant shrinkage of the financial services industry.

To see the scale of the problem, it’s important to start with Europe’s rolling sovereign-debt crisis. Core European countries, led by Germany, are hammering out an expanded bailout facility for a “periphery” sinking under the weight of unmanageable debt.

So far, the bailouts have been structured as loans, albeit with ever longer maturities on ever better terms. But loans nonetheless. That’s because core European governments are terrified their voters will rebel at a deal that would entail massive transfers to pay off peripheral Europe’s debts. But peripheral European countries already can’t pay back what they owe. New debt, even on better terms, doesn’t solve the problem.

The scale of austerity demanded of peripheral Europe’s populations and scale of debt service needed to pay back loans is already beyond what these countries will be able to tolerate for long. And they need new loans.

The latest estimates are that Irish banks will need as much as another €23 billion to meet tightening capital requirements. Although Spain is not yet in the same boat as Ireland, Portugal and Greece, it runs the risk. By some estimates, its banks will need as much as another €70 billion of capital, although it’s not clear what the scale of real-estate losses they have on their books really is.

Spanish real-estate prices have been marked down by an improbably small amount given the vast amount of overcapacity.

This is why the likes of Ireland have been talking about imposing losses on bondholders. These losses are not acceptable to core Europe because they would fall on their own banks, which are heavily exposed to peripheral Europe. But when push comes to shove, it’s likely to be more politically defensible for these countries to refinance their own banking sectors than to bail out foreigners. This, though, is likely to come at a price.

Although Basel III, the latest internationally-agreed set of regulatory requirements for banks, will increase capital requirements and shore up standards in an effort to prevent a repeat of the 2008 crisis, people at the Bank of England think this isn’t enough. And the Bank of England’s strongly antagonistic approach to the banking sector could yet become the new orthodoxy.

Lord Turner, head of the U.K.’s Financial Services Authority, captured the spirit of the Bank of England’s thinking when he argued in 2009 that much of the financial sector’s activities are “socially useless.” More recently, Bank of England Governor Mervyn King said he was astonished at how relatively muted public resentment was towards banks. David Miles, an external member of the Bank’s Monetary Policy Committee, called for much higher capital requirements, arguing that a doubling of the amount of capital banks need to hold would only increase the average cost of banks’ funding by up to 40 basis points. And Andrew Haldane, director for financial stability at the Bank, has called for banks to issue many more so called coco securities, debt which converts into equity when certain capital thresholds are triggered, particularly as a component of bankers’ bonuses.

The independent commission on U.K. banking, which is due to report in mid-April, is likely to call for significantly more stringent requirements than Basel III demands. Its conclusions will be informed by the Bank of England. Critics argue this would be killing London’s golden goose; that business would move abroad. But given the industry’s massive externalities, made obvious by the huge economic cost of bailing out banks in the wake of the 2008 crisis, that’s no bad thing.

Another European bailout of its banking system will merely reinforce the point. They also argue that forcing banks into probity just hurts the economy. Look how little lending is being done in the U.K., they say, causing economic growth to stagnate. U.K. real-estate prices are still not far from their bubble peaks on a price to household earnings basis. Is it really a bad thing that banks aren’t lending against overvalued asset prices?

As for not lending to businesses, Chris Dillow, an economist writing for the Investors Chronicle, pointed out that U.K. non-financial corporate profits jumped by nearly 20% in the fourth quarter of 2010. At the same time, corporate investment as a proportion of retained earnings fell to its lowest proportion since the data series began in 1987, and is little more than half the average proportion.

This suggests the U.K. corporate sector’s unwillingness to expand has less to do with access to finance, than with concerns about the prospects for generating a reasonable return on investment.

Short URL
Asymptotix on Twitter

Are the key legislative pillars such as Basel II & III, UCITS IV and Solvency II forcing you to re-examine how you identify, measure and manage risk and capital?

Asymptotix work closely with our partners to help clients develop a more proactive, systematic and integrated approach to governance and risk management to deliver proper value.

Asymptotix can offer the support you need to deliver on time. Read more...

Is the goal of your website to sell services or products, educate, or collect data?

A positive customer experience is vital to conversion, no matter what your conversion goals may be. Our designers and developers will create a positive experience to maximize your conversions and deliver the optimal return on your investment. We strive to find the perfect balance between the web site’s design and functionality.

Asymptotix implements interactive solutions for European companies. From corporate websites to social communities, our clients will tell you an investment in building a scalable online experience will deliver long-term tangible benefits.

Based in Luxembourg we can help you all over Europe. Our multi-lingual team can work with projects and speak your language! Read more...