The true implications of higher capital adequacy requirements under Basel III remain largely unquantified given that guidance over the scale and scope of risk weighted capital banks are required to set aside against assets varies considerably. CFOs and treasurers truly face a rapidly changing global banking landscape.
Corporates are therefore placed in a difficult position of preparing to adapt to the ‘new normal’ of higher compliance requirements, yet not clearly understanding the additional cost, risk management and administrative burdens this entails. What is clearly apparent is that although the Basel III capital adequacy rules are outwardly aimed at banks and financial institutions, businesses will be impacted significantly more than previous iterations of the Basel capital frameworks. Although the timing of enforceable reserve capital undertakings have not yet been defined, corporates who do not begin to prepare immediately will be placed in a precarious position.
The influence of the Basel III framework implementation over the coming year on routine business banking operations is a key challenge. Applying new treasury management systems, developing cross border trade capabilities and reducing working capital constraints will quickly reduce in priority as the full regulatory implications of the Basel III liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) becomes clearer.
The LCR requires banks to maintain high quality liquid assets such as cash and bonds, which can be easily liquidated and withstand a stress test event. The purpose of the NSFR is to ensure a minimum amount of stable funding over a one-year time period. The LCR is essentially a short-term instrument attached to the Basel III framework, in contrast to the NSFR, which is a longer-term regulatory lever.
The specification of global systemically important banks (GSIBs) effectively captures the full array of banking providers international organizations will potentially deal with. This adds to the primary need for banks to hold more capital against loans and assets and undoubtedly will raise the cost of credit and pricing of rates and deposits. Regulatory authorities and banks are afforded a high level of flexibility in applying global regulatory requirements. Standardizing the approach to risk-weighted assets is a key challenge that the Basel Committee is actively addressing, given the inability of banks in different countries to accurately compare their current level of capitalization.
Banks are clearly moving to leverage their core competencies in transaction banking, payments, business FX, wealth management or trade finance while actively rationalizing non-core operations. HSBC for example is currently preparing to ‘ring fence’ its domestic retail bank from riskier elements of the business at a cost of up to £1.5 billion. Bank of England Governor Mark Carney stated that “new regulations such as ring fencing will enable GSIBs to be wound down if they fail without the need for taxpayer-funded bailouts.”
The Australian Prudential Regulatory Authority (APRA) has taken it upon itself to set benchmarks to determine “unquestionably strong” capital adequacy classifications for Australian banks. APRA’s current judgement is that Australia’s largest banks are required to increase capital adequacy ratios by 2 percent relative to their position last year in order to be securely placed in the top quartile of their international peers in the long term. Capital requirements would increase for the Big Four major Australian banks by A$25 billion to A$30 billion. This process is intended to be undertaken gradually over the coming years, allowing banks and businesses time to adjust their internal risk weighted models, pricing and key relationship focus.
Where banks are no longer capable of providing competitive pricing, value for money and market leading service standards, alternative fintech providers are presenting in greater numbers. It is clear that banks are currently in a holding pattern in terms of their reaction to new entrants and non-bank competitors. Innovative technology and new platforms will continue to attract more customers at the fringe. Disrupters are seeking to address any shortfalls in customer satisfaction and perceptions of value for money encountered by banks grappling with higher regulatory costs and compliance burdens.
Trade finance is an area where the motivation to generate greater profits with less resources is clearly evident. The need to hold substantially higher capital decreases the volume of capital available to support trade finance operations. Profitability has been negatively impacted, resulting in many providers consolidating their product and service offering. This trend began in earnest following the global financial crisis yet continues to evolve on the back of Basel III regulatory capital regulations.
East & Partners Asia Trade Finance report, based on 937 direct interviews with CFOs across 10 Asian countries, revealed that nearly 60 percent of institutional enterprises are unsure of their planned supply chain solution. About 42 percent primarily source trade finance advice through friends and colleagues, while 34 percent base their decisions on feedback from their own customers or suppliers.
The sentiments of Asian corporate treasurers are echoed in Australia, where East & Partners Australian Trade Finance report, based on 1,813 interviews with SMEs, corporates and institutional enterprises, showed more than three out of four enterprises market wide seeking advice from customers or colleagues. Surprisingly, one in two institutional enterprises currently source trade finance advice from competitor banks. This emphasizes the importance of strong bank relationship management and opportunities for non-bank competitors.
As banks are forced to allocate greater resources against assets and increasingly focus on KYC and AML requirements, maintaining market leading value for money, service standards and pricing will be a major challenge. Corporate treasurers are clearly already on the front foot investigating alternative providers and in many instances moving beyond their relationship manager to source valuable strategic guidance and advice.Martin Smith is head of markets analysis for East & Partners, based in Sydney, Australia.