• Changes to make sovereign-bond trading more difficult: Survey
  • BIS releases findings of informal survey of 40 banks

New regulations are set to push up costs of capital for government-bond dealers, potentially making trading and market-making more difficult, according to a Bank for International Settlements survey.

The informal poll, conducted between August and September among 40 banks, showed respondents expected the increase when they move from the initial Basel II rules to a fully phased-in Basel III, the report published on Thursday said. The survey was part of the BIS’s study on fixed-income market liquidity as it sought to assess various factors that may affect dealers’ ability to take on risk and facilitate trading. 

“Market participants have raised concerns that regulatory reforms, by raising the costs of warehousing assets, have contributed to reducing market liquidity and could be keeping banks from acting as shock absorbers during periods of market stress,” the organization said in the report produced by its Committee on the Global Financial System. 

The gross revenue required to yield a return on capital of 8 percent under Basel III rules would have resulted in returns above 20 percent under Basel II. That’s according to the implications of the survey commissioned by the BIS, the 85-year-old coordinator of the world’s biggest central banks.

Rulebook Reasoning

The Basel Committee on Banking Supervision, a group of financial supervisors from most the biggest economies, overhauled its rulebook after the 2008 financial crisis showed banks had too little capital to withstand losses, and that the quality of the capital they did have wasn’t sufficient to employ it quickly.

The overhaul, dubbed Basel III, also forces banks to hold more assets they can sell quickly if money markets dry up, and it tries to close loopholes banks used to understate the risks on their books.

“For the sovereign-bond example, both the Basel III leverage ratio and higher risk-weighted capital requirements were considered as having the largest impact on regulatory capital charges and, hence, dealers’ profits,” the report said.

Building Inventories

Banks are shrinking their bond-trading activities to comply with regulations such as Dodd-Frank in the U.S. and Basel III, which were put into place to keep financial firms from taking the types of risks that led to the last financial. These restrictions have reduced their ability to build an inventory of securities that carry risk.

The retrenchment has already led to job cuts in the industry, with Morgan Stanley eliminating 1,200 workers worldwide, including about 470 traders and salespeople in its fixed-income and commodities business. Credit Suisse Group AG, Barclays Plc and UBS Group AG have also pulled backed from some trading operations.

Adding to the challenges for investors to buy or sell their bonds without disrupting prices is monetary-policy easing in most major economies, which in some cases includes bond purchases, according to the report.

“One such challenge is scarcity effects, given that large-scale asset purchases reduce the amount of securities available for trading,” the report said. “A second challenge relates to the risk that valuations may have become predicated on unsustainable expectations of continued monetary policy accommodation.”

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