Martin Kling's picture

On September 12th the Basel Committee on Banking Supervision (BCBS), today's most known part of the Bank for International Settlements decided to issue new and increased guidance on the necessary capital resources (equity capital) for financial institutions. Over a given period the percentage of core capital will be increased substantially from 4% to 6% plus additional buffers. This should give banks reserves to cope with the next financial crisis to come.

It is to be noted though that the status of the Basel papers is those of recommendations that need to be realized by national law. Usually though the countries follow those recommendations closely. In this case it may be expected that some countries will even tighten the requirements further - Switzerland already commented on the need to impose even higher rates on the Swiss banks Credit Suisse and UBS as a crash of those would most likely take the Swiss economy with them.

A big discussion point will be the exact definition what has to be counted as core capital. This can already be noted in the reactions of banks on the regulations. E.g. banks that have so called quiet reserves feel that those should be counted as core equity and claim that the differences in the credit business are not reflected to satisfaction. However, in general the reactions from banks and politics are mostly positive on that topic.

But what does the increase in equity capital actually mean for the stability of the financial system? Obviously they will prevent banks go bankrupt to a certain degree. To achieve the needed levels of capital reserves though the banks will have to accumulate money - that is not available for credits or other types of business or dividends to shareholders. Even if some banks like the Deutsche Bank embrace the regulations and are the first to announce a capital increase to fulfill the regulatory demands already in 2013 the increased capital reserves will affect economy - to what impact can only be guessed but should be affordable.

For sure it is to be expected that the existing practice to loosen the requirements for a institution that is able to proof a working risk management and internal control process will continue. So the new regulations will increase the need for methods and tools to keep the necessary balance in their processes. (I included a picture you may know from my presentations to illustrate this balance.)

Balance!From a methodological point of view these measures simply mean to take back performance goals to ensure lower risk and higher level of stability and control. In banking the commonly expected profit margins of above 20% for a long time meant to work with leveraging effects - that is working with the money of others. Increasing the amount of capital reserves in the end must lead to reduced profit expectations.

One major point of wonder after the crisis continued to be the observation that performance goals still seemed to stay the same. Everybody just seems to follow the famous words of Stirling Moss: "If everything is under control, you are just not driving fast enough." The difference is that this guy accepted the risk of a deathly crash - managers do usually not accept such levels of risk. So we can only hope that the new regulations will tip the scales towards a new balance with more emphasis on risk control than on profit margins.


Tags: GRC LoungeTalk