BASEL III

Basel III



Executive Summary

Basel III will have significant impact on the European banking sector. As the rules are written today and based on Q2 2010 balance sheets, by 2019 the industry will need about £1.1 trillion of additional Tier 1 capital, £1.3 trillion of short-term liquidity, and about £2.3 trillion of long-term funding, absent any mitigating actions. The impact on the smaller US banking sector will be similar, though the drivers of impact vary. We estimate the Tier 1 capital shortfall at £870 billion, the gap in short-term liquidity at £800 billion (£570 billion), and the gap in long-term funding at £3.2 trillion. The capital need is equivalent to almost 60 percent of all European and US Tier 1 capital outstanding, and the liquidity gap equivalent to roughly 50 percent of all outstanding short-term liquidity. Assuming a 50 percent retained earnings payout ratio and nominal annual balance-sheet growth of 3 percent through 2019, capital requirements in Europe are expected to increase to about £1.2 trillion, short-term liquidity requirements to £ 1.7 trillion, and long-term funding needs to about £3.4 trillion. Closing these gaps will have a substantial impact on profitability. Overall, it is unlikely that banks will be able to offset Basel III's impact on profitability. Despite the long transition period that Basel III provides, compliance with new processes and reporting must be largely complete before the end of 2012. For an average midsize bank, we estimate that the technical implementation alone will add about 30 percent to 50 percent to the significant outlay already incurred for Basel II. Implementing the new rules will require three distinct initiatives: strategic planning for the Basel III world, capital and risk strategy, and implementation management.

Basel III

Introduction

On September 12, 2010, the Basel Committee for Banking Supervision (Basel Committee) endorsed the annex it had issued on July 26 (July 2010 Annex) and specified further details for capital requirements, in particular target ratios and the transition periods during which banks must adapt to the new regulations.1 The results have now been endorsed at the just-concluded G20 summit in Seoul. With that, and except for the forthcoming treatment of systemic institutions, it appears that Basel III, as the new rules are commonly known, is largely complete.2 The new regulation aspires to make the banking system safer by redressing many of the flaws that became visible in the crisis. Improving the quality and depth of capital and renewing the focus on liquidity management is intended to spur banks to improve their underlying risk-management capabilities. The rationale is that ultimately, if banks come to a fundamentally revamped understanding of their risks—what we call a new risk paradigm—that should be good for their business and for consumers, investors, and governments. Basel III's focus is on capital and funding. It specifies new capital target ratios, defined as a core Tier 1 requirement of 7.0 percent (further specified as a minimum of 4.5 percent of core Tier 1 capital and a required capital conservation buffer of ...