basel iii endgame sounds more like an ominously titled spy thriller sequel than the last stage of u s regulators implementation of reforms meant to ensure the stability of the banking system however the banking industry has depicted the reforms which largely call for the country s largest banks to put aside more capital in reserve to weather financial storms as a threat to the american economy in a lobbying blitz basel iii s supporters have called unprecedented the banking lobby has amassed an army of lobbyists in washington d c and poured millions into a media campaign to denounce the proposed regulations 1
understanding basel iiithe regulations date to the wake of the 2007 to 2009 financial crisis when financial watchdogs worldwide met to discuss ways to avoid a similar catastrophe in 2009 they agreed through the international basel committee on banking supervision to develop minimum capital leverage and liquidity requirements to ensure major banks could survive another upheaval 2 the final components of basel iii known as basel iii endgame in the united states designed and set to be implemented by regulators at the federal reserve the federal deposit insurance corporation and the office of the comptroller of the currency was sent out for comments in mid 2023 3lobbies like the bank policy institute have taken to the airwaves and online warning that the suggested regulations which targeted only about 37 u s banks with holdings of 100 billion in assets or more would put young families dreams of homeownership and small businesses expansion plans at risk 4 the banks claim the reforms would not make them any more stable and would have knock on effects on their ability to lend funds to those with less credit including minorities who have historically faced problems obtaining credit from american financial institutions 56soon after the end of the commentary period in early 2024 federal regulators were already backtracking on their initial proposals from 2023 which made the rules defenders furious 7 when the heat was on last year you talked a lot about getting tougher on the banks u s senator elizabeth warren told jerome powell chair of the federal reserve during a march 7 2024 congressional hearing now the giant banks are unhappy about that and you ve gone weak kneed on this 8the final regulations are set to be released with enough time to take effect on july 1 2025 at that point a three year phase in of the regulations would begin 9 but what exactly does basel iii entail and why has it led to such heated rhetoric in the financial world below we go through what s in the reforms how they would impact banks and why what happens to basel iii endgame is important for everyday investors investopedia sydney burnsa deeper dive into basel iiibasel iii was rolled out by the basel committee on banking supervision a consortium of central banks from 28 countries based in basel switzerland shortly after the financial crisis of 2007 2008 10 many banks were overleveraged and undercapitalized during this period despite earlier reforms called basel i and basel ii also called the third basel accord basel iii is a continuing effort to strengthen an international banking framework that began in 1975 the basel i and basel ii accords aimed at improving the banking system s ability to deal with financial stress improve risk management and promote transparency the first basel accords were introduced in 1988 and came on the heels of that decade s debt crises in latin america basel i required banks to hold 8 of their risk weighted assets as a buffer against potential losses this was a significant step in ensuring that banks had enough financial strength to withstand losses and didn t jeopardize the rest of the financial system following basel i and the many changes in the financial markets in the dot com era further measures were deemed necessary leading to basel ii in 2004 basel ii introduced more sophisticated models for calculating risk expanding beyond credit risk to account for operational and market risks losses due to changes in market prices basel ii also encouraged banks to build their own internal models to better assess the specific risks they faced it didn t take long though before the approach of basel ii already looked outdated given the banking storms of the 2007 2008 period the transition from basel ii to basel iii would mark a significant shift in the global approach to banking regulation while basel ii focused primarily on the amount of capital the banks held and how they managed risk basel iii included new rules on liquidity leverage and systemic risk factors 11many parts of basel iii are already in place worldwide including the u s however the final changes called basel iii endgame and agreed upon in 2017 have been delayed for years by the covid 19 pandemic and banks calling for more time to adjust to and lobby against the new regulations 12 deadlines have come and gone with mid 2025 the latest date for when the rules are supposed to go into effect in the u s which means announcing them months earlier to provide regulators banks and other stakeholders the time needed to prepare to meet the new standards banks would start using the rules on july 1 2025 with the goal of having them fully in place three years later 9basel iii endgame includes updates to how banks calculate the risk of people not paying back their loans how they use their own internal models to determine how much money they need to keep in reserve and how they should handle operational risks like fraud or system failures let s go through each of these areas before turning to what this all means for everyday investors minimum capital requirements under basel iiibefore starting it s worth reviewing that banks have two main silos of capital to work with tier 1 is a bank s core capital equity and reserves that appear on the bank s financial statements if a bank experiences significant losses tier 1 capital is what can allow it to weather stress and keep its doors open by contrast tier 2 refers to a bank s supplementary capital such as undisclosed reserves and unsecured subordinated debt instruments tier 1 capital is more liquid and more secure than tier 2 capital 13under the proposed basel iii endgame banks with over 100 billion in assets would have to keep more money in their reserves to cover potential losses 14 the new rules would allow banks to calculate the riskiness of assets like loans and investments in multiple ways they d have to use whichever method puts aside more capital to err on the side of safety and stability an important type of capital banks would need more of is called common equity tier 1 cet1 this includes the money banks get when they issue stock and the profits they hold onto instead of paying out to shareholders big banks would also have to keep a minimum level of capital as a proportion of all their assets including things that aren t on their main balance sheet not just the risky ones if the economy is doing well regulators could make banks hold even more capital to prepare for a possible downturn banks would also need a minimum of 6 of their risky assets in tier 1 capital including cet1 and a few other super safe investments the minimum for total capital tier 1 plus tier 2 which is slightly riskier would stay at 8 13so while the total capital ratio tier 1 tier 2 remains at 8 as it s been since basel i the composition of what banks can use as that capital is changing with a greater emphasis on higher quality forms of capital since it s also changing what it s a percentage of removing any consideration of riskier capital tier 3 from the calculation 1516 that would mean the way banks calculate their risk weighted assets the denominator or bottom figure in the capital ratios would change thus while the 8 figure might look the same the changes to the capital ratios numerator and denominator and new buffer requirements mean that basel iii endgame would increase capital requirements for the banks targeted by these regulations 16 estimates have varied with the higher ones coming from the banking lobby but the biggest banks would need to increase the amount of capital they have on hand by up to 20 over what they keep in reserve now 176basel iii introduces new capital buffer requirements that banks must maintain above the minimum capital ratios these buffers are designed to ensure that banks build up capital reserves during good times that they can draw down during economic and financial stress periods basel iii also introduced new leverage and liquidity requirements to protect against excessive and risky lending while ensuring that banks have enough liquidity during periods of financial stress in particular it sets a higher leverage ratio for g sibs the ratio is tier 1 capital divided by the bank s total assets with a minimum ratio requirement of 3 21in addition basel iii has new liquidity rules a liquidity coverage ratio requires that banks hold a sufficient reserve of high quality liquid assets hqla to allow them to survive a period of significant liquidity stress lasting 30 calendar days 22 hqla includes cash central bank reserves and certain government securities that can be easily converted to cash with little or no loss of value 23another liquidity related provision is the net stable funding nsf ratio which compares the bank s available stable funding essentially capital and liabilities with a time horizon of more than one year with the amount of stable funding that it must hold based on the liquidity outstanding maturities and risk level of its assets the bank s nsf ratio must be at least 100 the aim is to create incentives for banks to fund their activities with more stable sources of funding on an ongoing basis rather than load up their balance sheets with relatively cheap and abundant short term wholesale funding 24