Banks Catch a Break with Long Timeline for Implementing Basel III Regulations

By: Money_Morning

Kerri Shannon writes: Global regulators on Sunday agreed on new banking capital requirements - known as Basel III - that were much less severe than expected, boosting global financial stocks as investors were optimistic about banks' ability to comply.

The Basel Committee on Banking Supervision agreed on new rules that will more than triple capital requirements to give banks a bigger cushion against losses. Banks will have to raise the amount of common equity they hold to 7% of assets, up from 2%.

While the increase seems steep, regulators compromised on the timeline, agreeing to start phasing in the rules by Jan. 1, 2013 and allowing eight years for full implementation. The uneven state of economic recovery deterred countries from trying to enforce the rules sooner.

"The recovery is slow and we want to move to these higher standards in a gradual way," Stefan Walter, secretary general of the Basel Committee, told The Wall Street Journal. "It's a balanced approach."

Banks will have less than five years to boost common equity reserves to 4.5% of assets, and will have until Jan. 1, 2019 to collect the additional 2.5% reserve buffer. If banks dip into the buffer amount or fail to meet the holding requirement, they would face restrictions on paying shareholder dividends and executive compensation, but would not be forced to raise cash.

The Basel Committee also will allow banks to apply government bailout funds toward capital reserves until the end of 2017.

While countries like Germany wanted to give institutions up to ten years to meet the new standards, nations that have already tightened banking regulations, like the United Kingdom and Switzerland, pushed for a five-year time line.

"The implementation period is much longer than expected, which is generous to the sector, " Credit Suisse Group AG (NYSE ADR: CS) analysts wrote in a note to clients. "The fact that the sector now has a greater degree of certainty about capital requirements going forward ought to act as a material positive catalyst. "

Besides providing a protective cushion for future crises, the rules are meant to create a more transparent banking sector. The Basel III regulations include provisions like giving incentives to banks that trade certain derivatives on open markets instead of privately between institutions, and strictly defining risk weighting to prevent banks from finding accounting loopholes.

Some banking supervisors complained that higher capital requirements and limited investment behavior would restrict lending abilities, drive up borrowing costs and reduce banks' profitability by discouraging lucrative investments.

But many experts disagree, saying the higher capital ratios usually have little bearing on bank lending and are not drastic enough to significantly change the industry - except by making it a more trustworthy operation.

"It will make banks less profitable, probably, " Joe Peek, professor of international banking and financial economics at the University of Kentucky, told The New York Times. "But it will make the system safer, because there will be more of a cushion from insolvency, so banks can withstand more of a hit and still walk away alive. "

While experts were happy to hear a decision, some think the long phase-in period is too long and makes it too easy for banks to comply. Dennis Gartman, editor of "The Gartman Letter, " called the timeline "comical. "

"If you're going to put in capital requirement increases, do it swiftly, get it done, " Gartman told Bloomberg. "A lead in of this many years is, I think, beyond belief. When you give somebody nine years to accomplish a task, normally that task never gets accomplished. "

Other economists warned that the long timeframe means supervisors will need to reevaluate the standards to make sure they are still as effective as intended in a few years to prevent another banking problem.

"I think we're going to have to be clearly careful as time wears on and the memory of all this starts to fade, that the risk management procedures…seem robust enough to fend off this kind of a problem. That's something the supervisors are going to have to work real hard at, " William R. White, chairman of the Organisation for Economic Co-operation and Development Economic and Development Review Committee, told Bloomberg.

Bank Stocks Boosted By Investor Optimism
Investors welcomed the less severe rules and pushed bank stocks higher Monday.

Australia's Treasurer Wayne Swan announced the nation's banks would "comfortably meet " the new requirements, and the Commonwealth Bank of Australia rose 1.59% on the news.

Japan's biggest bank, Mitsubishi UFJ Financial Group Inc (NYSE ADR: MTU) rose 3.56%.

Asian banks have kept higher capital ratios and are not expected to need to restructure or raise funds to meet the new raised standards.

"Today if you look at the whole of Asia, Tier 1 capital is more than 10% to 12%, " Zhu Min, special adviser to the International Monetary Fund (IMF) and former deputy governor of China's central bank, told Bloomberg. "I don't think Asian banks at the moment will go to the markets to raise a lot of capital. "

U.K. banks should also have little trouble complying. Europe's biggest bank HSBC Holdings PLC (NYSE ADR: HBC) was up 2.26% Monday and analysts said the company could boost its dividend now that there's less uncertainty surrounding capital requirements.

"We expect the market to respond positively to a more regulatory certain environment and we would expect investors to focus on capital return for those banks where we see the strongest balance sheets, " JPMorgan Cazenove analysts wrote in a report on the U.K. banking sector.

Morgan Stanley (NYSE: MS) analysts Henrik Schmidt and Huw van Steenis said Nordic banks would likely be the first to raise dividends, followed by the Swiss.

U.S. banks that might be the first to increase dividends include JPMorgan Chase & Co. (NYSE: JPM), U.S. Bancorp (NYSE: USB) and Northern Trust Corp. (Nasdaq: NTRS), according to the report.

"The largest American banks are already in compliance with the central tenet of Basel III, " and already maintain a 7% Tier 1 capital ratio, head of NAB Research Nancy Bush told The Journal.

JPMorgan rose 3.4% in trading Monday, Bank of America Corp. (NYSE: BAC) was up 2.95% and Goldman Sachs Group Inc (NYSE: GS) jumped 2.58%.

Analysts expected German and Italian banks to need to raise more funds than their European counterparts. Deutsche Bank AG (NYSE: DB), Germany's biggest lender, is aiming to raise $12.63 billion (9.8 billion euros) in a stock sale at the end of the month. Italy's banks will benefit from the eight-year time frame as they have some of the lowest capital levels among European lenders.

The details of the regulations could alter from country to country as nations adopt the rules into law.

"Every country is going to face pressure from its banking industry to interpret the rules in a way that favors their banks, " David Andrew Singer, a political scientist at Massachusetts Institute of Technology, told The Times.

The new rules need approval from the Group of 20 nations, scheduled to meet in South Korea in November.

Source : http://moneymorning.com/2010/09/13/basel-iii/

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