Basel Would Have Left Banks With $797 Billion Capital Shortfall

Basel bank regulators said rules on capital requirements would have forced financial institutions to raise 602 billion euros ($797 billion) of capital had they been in place at the end of last year.

Lenders would also have had a 2.89 trillion-euro shortfall in the funds needed to guard against a run on deposits had the planned Basel Committee on Banking Supervision’s rules been in place at the start of 2010, the panel said in a statement on its website today. The committee agreed in July to phase in the capital and liquidity rules by 2019 in a bid to mitigate their effect on banks emerging from the credit crisis.

Regulators are overhauling bank liquidity and capital requirements because existing rules, known as Basel II, failed to protect lenders from insolvency during the financial crisis. The main elements of the overhaul were approved by leaders of the Group of 20 countries last month.

The shortfall projected by the Basel committee is a “vivid demonstration of the sheer impact of the new liquidity standards,” said Etay Katz, regulatory partner at law firm Allen & Overy LLP in London. “There is a considerable concern about finding an effective way of bridging such a shortfall -- bar drastic changes to business plans and business disposal programs which may be unfeasible or imprudent.”

Photographer: SeongJoon Cho/Bloomberg

Nout Wellink, president of the Netherlands Bank and chairman of the Basel Committee of Banking Supervision. Close

Nout Wellink, president of the Netherlands Bank and chairman of the Basel Committee of... Read More

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Nout Wellink, president of the Netherlands Bank and chairman of the Basel Committee of Banking Supervision.

Lenders would have had a 2.89 trillion-euro liquidity shortfall against a net stable funding ratio at the end of 2009, the Basel committee said. That ratio, slated to be put in place in 2018, aims to limit the mismatch between the duration of loans and deposits to ensure banks don’t face funding shortages.

Liquidity Coverage

Lenders at the end of 2009 would also have had a shortfall of 1.73 trillion euros in the assets required to meet a separate liquidity coverage ratio, which gauges banks’ ability to survive a 30-day credit crunch. That ratio is scheduled to be effective from 2015.

The two shortfalls aren’t “additive,” the Basel committee said. “Decreasing the shortfall in one standard may result in a similar decrease in the shortfall of the other.”

Banks that fail the minimum liquidity requirements could meet them by lengthening the term of their funding or restructuring business models, the Basel committee said.

“Funding is gradually becoming the key concern,” said Arturo de Frias, head of banks research at Evolution Securities Ltd. The Basel figures showed that “only” 67 percent of banks analysed had 85 percent of the stable funding needed to meet the net stable funding ratio, he said.

Anywhere Close

“If the funding markets remain this difficult, many banks will not get anywhere close to their 100 percent NSFR minimum in 2011,” De Frias said.

The Basel committee has said that it will collect data on both liquidity standards before they are introduced, and amend them if needed.

“We will use the observation period for the liquidity ratios to ensure that we have gotten their design and calibration right,” Nout Wellink, committee chairman, said. The panel will ensure that “there are no unintended consequences, either at the banking sector or broader system level.”

The Basel committee said the 602 billion euros in extra capital would have been needed for banks to cope with a requirement to hold core reserves equivalent to 7 percent of their assets, with these assets weighted according to their riskiness. The figure was based on data from 263 banks.

Transition Period

“The transition period provides banks with ample time to move to the new standards in a manner consistent with a sound economic recovery,” Wellink, said.

Banks that don’t meet the requirement when they enter into force will face restrictions on paying dividends, regulators have said.

The Basel committee said that it surveyed 94 international banks with more than 3 billion euros in Tier 1 capital, a broader measure of lenders’ reserves. It said that these would have needed an additional 577 billion euros of core capital to satisfy the new rules. This sample of banks had net income of 209 billion euros in 2009, the Basel committee said.

The other 169 banks surveyed would have needed 25 billion euros, the Basel committee said.

The 577 billion euro figure should not be taken as an accurate assessment of how a bank will cope with the capital rules, de Frias, said.

‘Capital Hole’

“Assuming a 60 percent profit retention, the capital hole would have been plugged in five years,” de Frias said. The amounts were also “probably irrelevant” given plans being developed by regulators to impose extra requirements on systemically important lenders.

Meeting the capital rules “will cost banks a lot of money, but there’s no alternative,” Konrad Becker, a banking analyst at Merck Finck & Co. in Munich, said by telephone today. “The question is how to do: with retained earnings, selling assets, capital increases or lower dividends.”

“The actual impact” of the capital requirements “by the time they are implemented will likely be lower as the banking sector adjusts to a changing economic and regulatory environment,” the committee said in its impact report.

The results “do not consider banks’ profitability or make any assumptions about banks’ behavioral responses,” the report said.

No ‘Extreme Danger’

“I don’t see an extreme danger for economic growth and the long transition period to 2019 should reduce such risks,” Becker said. “The new standards are doable and sensible. Making the banking system more stable and safe doesn’t come without costs. You can’t do the one without the other.”

Nomura Holdings Inc. analysts led by Jon Peace wrote in a report to clients today before the Basel report was published that they expect banks will meet the demands of the new rules by retaining earnings rather than selling shares.

“We do not predict a flood of equity issuance to comply with Basel III,” the Nomura analysts said.

Banks based in the 27-nation European Union would have needed 263 billion euros of additional core capital to meet the 7 percent threshold agreed by Basel regulators, the Committee of European Banking Supervisors, which collected data from its lenders for the Basel impact study, said. The CEBS figures are based on data from 246 banks based in the EU.

Italian banks alone would have needed 40 billion euros as of June, the Bank of Italy said in a statement today.

Regulatory Overhaul

The Basel committee today published a so-called rules text clarifying the details of the regulatory overhaul. As well as revised rules on capital and liquidity, the plans also include a limit on banks’ borrowings.

“There are few surprises here, but some important details,” Credit Suisse Group AG analysts said about the Basel rules text.

Changes to one of the two liquidity ratios planned by Basel regulators would “benefit Nordic and other retail banks” by accepting that covered bonds are more liquid than previously thought, the Credit Suisse analysts wrote in an e-mailed statement.

The Basel group also published proposals for national authorities on countercyclical capital buffers, aimed at bolstering capital during credit booms.

Under the plan, banks would hold extra capital during credit booms with the aim both of mitigating them and of ensuring than banks are well capitalized for any ensuing market crash.

The Basel committee brings together regulators from 27 countries including Brazil, China, India, Germany the U.K. and the U.S.

To contact the reporters on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net.

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net.

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