Basel III and Its Consequences: Confronting a New Regulatory Environment

Basel III will put increased pressure on banks’ profitability. Accenture analyses the new Basel III requirements and explores the issues, identifying a range of possible operational, tactical and strategic responses that will help position banks for high performance during the next crisis.

Recent financial crises pinpointed numerous weaknesses in the global regulatory framework and in banks’ risk management practices. New measures by regulatory authorities include a move to strengthen global capital and liquidity rules—an initiative known as Basel III.

Basel III reform introduces several new or enhanced rules, including a new and stricter definition of capital and a new global liquidity standard. It also increases capital requirements for counterparty credit risk arising from derivatives, repurchase agreements and securities financing activities.

The new regulations will increase capital requirements and drive up capital as well as liquidity costs and thus increase pressure on banks’ profitability.

According to the current Basel III consultation paper, the new rules will come into force on January 1, 2013, with full implementation by 2019. Timelines are expected to vary between regions, and some amendments to the rules have already been made.

Basel III’s range of new and stricter regulations will undoubtedly hit banks hard. Among the negative effects are:

• Stricter capital definition that lowers banks’ available capital, while the risk-weighted assets for certain transactions are significantly increased. Both will decrease banks’ realized capital ratios enormously.
   
• The introduction of new liquidity ratios (short-term and longer-term) will force banks to rethink their liquidity positions.
  
  
• The introduction of a non-risk based leverage ratio of 3 percent, which a significant subset of Group 1 banks failed to meet.

Generally, banks will experience increased pressure on their return on equity due to increased capital and liquidity costs, which, along with increased risk weighted assets will put pressure on margins across all segments.

To become compliant and restore profitability, banks can take a number of measures.

• Operational responses. Basel III creates incentives for banks to improve their operating processes, not only to comply but also to increase efficiencies and lower costs.

• Tactical responses. A focus on more far-reaching tactical responses in pricing, funding and asset restructuring may be extremely helpful in relieving pressure on profitability.

• Strategic responses. Banks have the opportunity to effect major changes from fairly straightforward initiatives, such as retaining earnings to increase tier 1 capital, to more far-reaching possibilities. These possibilities include issuing new capital in light of the new eligibility criteria and phase-in arrangements; changing liquidity risk and funding strategies; and taking a more active approach to managing the balance sheet.

However, Accenture believes that, in the final analysis, even the most well-capitalized and managed banks will experience lower profitability in the post-Basel III environment despite the range of possible responses.

Accenture has been helping its clients use compliance with the various iterations of the Basel Accord to progress on their journeys to achieve high performance.

Michael Auer is an executive principal for Accenture Risk Management in Munich, Germany. He is responsible for German-speaking markets and has 18 years of industry and consulting experience in financial services and risk management across Europe working with global institutions to transform their business and risk capabilities.

Georg von Pfoestl is a manager at Accenture Risk Management. Based in Vienna, he has nearly eight years of experience in risk management with a focus on credit and liquidity risk, regulatory matters and risk-weighted assets optimization. His experience as a banking inspector at the Austrian National Bank has given him pragmatic knowledge from working with regional and international financial institutions across German-speaking markets and technical skills pertaining in Basel II and Basel III regulatory requirements.

Jacek Kochanowicz is a manager in Accenture Risk Management. Based in Frankfurt, he has nearly seven years of experience in risk management across Europe, the Middle East and South Africa where he worked with several regional and international institutions to improve their risk capabilities. His extensive experience includes risk management, especially credit risk, asset and liability management, economic capital and stress testing.