Basel Committee Softens Stance, Allows More Asset Classes & Relaxes Timeline

It looks like the Basel Committee was paying heed to the objections raised by the world’s biggest banks after all. Or maybe the millions of dollars that banks pumped into lobbying firms finally paid off. Either way, the Basel Committee has decided to water down the requirements it laid out as part of its draft proposal well over two years ago to come up with its final proposal. ^[1]

The new proposal includes three new classes of assets – corporate debt securities, equities and also residential mortgage-backed securities – that are admissible towards the calculation of a bank’s mandatory liquid asset base requirements. ^[2] The timeline for the implementation of Basel III requirements is also stretched by four years, with 100% compliance expected by 2019 instead of the original target of 2015.

The changes to the Basel III norms should be a shot in the arm for banks around the globe, with the relaxed requirements giving the big banks more room to maneuver their operations in a more profitable manner. More particularly, the biggest European banks – including Deutsche Bank (NYSE:DB), UBS (NYSE:UBS) and Barclays (NYSE:BCS) – stand to gain a lot from the Basel tweaks. This is why shares of these banks posted gains of 2-3% over trading on Monday.

See our full analysis for Deutsche Bank | UBS | Barclays

In the wake of the global economic recession of 2008, financial regulators around the world have been working on tighter rules to ensure sustainability of the banking groups in the event such circumstances repeat in the future. It can hardly be disputed that the Basel III norms formulated by the Basel Committee on Banking Supervision (BCBS) form the crux of the proposed financial sector reforms. While increasing the common equity and Tier I capital requirements laid out in Basel II, the Basel III norms also tighten the banks’ capital structure by proposing additional capital buffers, a minimum leverage ratio and adding mandatory requirement ratios – the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR).

The newly introduced changes pertains to the LCR – the ratio of a bank’s high quality liquid assets (HQLA) to its total net cash outflows over 30 days. The Basel Committee listed the assets that a bank can count towards the HQLA, and this raised a lot of concerns among banks since the draft of the rules were drawn in December 2010 because of its restrictive nature. But the list has been extended in the latest version of the Basel III norms, allowing asset classes like equities, corporate debt and even residential mortgage-backed securities subject to certain requirements – albeit with specific haircuts. ^[3] As banks already hold a considerable amount of these assets, they may find it easier to meet the LCR requirement and will save millions that they would have had to otherwise lock up in the assets listed earlier.

The banks will also be able to focus better on growing assets directly related to their businesses rather than in asset investments towards the regulatory requirement. Trading assets, for example, would see better growth over the coming years thanks to the improved rules. To see how an increase in UBS’s fixed-income trading assets affects its share value, you can make changes to the chart below.

Another lifeline the Basel Committee throws towards banks is the increase in the deadline for the implementation of new LCR rules. The LCR will be phased in from 60% starting 2015, with a 10% increase each year, extending the full compliance time frame to 2019.

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1. Group of Governors and Heads of Supervision endorses revised liquidity standard for banks, BIS Press Releases, Jan 6 2012 [↩]
2. Annex 2, BIS Press Releases, Jan 6 2012 [↩]
3. New LCR Requirements, BIS Press Releases, Jan 7 2012 [↩]