Of Special Interest


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22nd May 2012

Big Banks need $566bn to meet Basel III

Fitch calculate that the 29 Global Systemically Important Financial Institutions (G-SIFI) will need to raise an additional $566bn (€445bn £358bn ¥44.9tr Y3.58tr of capital by the end of 2018 to fully meet the Basel III capital rules. The sum is broadly inline with the previous estimate by the Bank for International Settlements of $489bn as BIS did not include the surcharge for the G-SIFI banks of between 1% and 2.5% which is part of the Basel III accord. Some countries such as the UK and Switzerland have already said they will require their SIFI banks to exceed this surcharge level. In addition the UK is planning to require retail banks to hold separate capital for its retail operations.

As a proportion of total bank capital it is 'a mere 1.2%' addition. Perhaps a better indication of the challenge comes from the ratio of the new capital required to common equity, which is 23%. Assuming that governments have the will to stick to the Basel III agreement, the new capital figure needed could still be much smaller than the amount above. This could be the case through the banks shrinking their risk weighted assets. This has been seen to a significant extent already with banks reducing their lending. Thus resulting in businesses finding it difficult to borrow and adding to recessionary pressures on many western world economies. Banks also have the option to reduce the capital used for proprietary trading. In the US, if the Volcker rule is applied in the way envisaged , the banks will have no choice but to severely cut any proprietary trading. In common with all of the options the ending or reduction of proprietary trading has its own cost in the good years, in terms of lower profitability.

Delivering the full capital amount from internal funding would reduce average return on equity from 10.8% currently to 8.5%. Many would see this as a reasonable way to solve the problem. It raises the issue however as to whether banks would be able to raise all of the equity they required given the lower return. Some of this group of banks have already set financial targets promising to deliver significantly higher ROE in addition. The third option discussed is that of cutting expense further.

It is likely that banks will adopt a mix of all three strategies. Fitch go on to hypothesise on how this mix may work out for the average Too Big To Fail bank, suggesting a reduction in earnings averaging $6bn during the period ( one year's earnings on average), the issuing of $6bn of additional equity and the reduction of $75bn in Risk Weighted assets.

There are more aspects discussed in the paper including banks seeking to drop down the rankings of Significant Importance so they will attract lower surcharges. As with many forecasts the numbers are also highly dependent on 'ceteris paribus', (all other things remaining equal). If various world problems were to cause a significant rise in bad debt this could radically change the figures. A large number of this group have significant insurance operations that will be affected by Solvency II. Both Solvency II and Basel III refer to the capital held by bancassurers and the current ability of bancassurers to double count the capital in certain circumstances.

The Fitch paper can be downloaded from:

[See also Newslink: Hedge funds & PE Firms plan European bank debt purchases ]