What are Basel III’s Implications for Canadian Treasurers?

Although banks actually have until 2019 to be fully compliant with the Basel III capital requirements, the Office of the Superintendent of Financial Institutions (OSFI) believes Canadian banks are strong enough to comply now. This is in stark contrast to the U.S. and Europe, where bank regulators have delayed implementation. But what does this mean for Canadian corporates?

Treasurers’ thoughts on the requirements are mixed. Some are concerned with how this might affect their banking costs and relationships, while others are unconcerned. The new guide from AFP of Canada and the Society of Canadian Treasurers, Canada First: Basel III’s Implications for Canadian Treasurers, examines these divergent views and provides insights into what some corporates are doing as the implementation period begins.

Nilly Essaides, AFP’s director of practitioner content development and author of the guide, explained that Canadian regulators’ rationale for going first is their drive to maintain financial stability leadership, which they have been championing for several years. Given Canada’s remarkable resilience following the financial crisis of 2008, regulators believe the country has an obligation to set an example.

“It’s been a point of pride, since Canadian banks have weathered the 2008 crisis in incredibly good shape, that they are considered the safest banks in the world,” said Essaides. “They would like to keep it as such. So they see themselves as leaders in the areas of financial regulation and the stability of the banking system.”

Corporate reactions

Many corporates are convinced that their credit, derivatives and transaction costs with banks will rise and they do not want to absorb those additional costs. “The banks talk about how these costs will have to be absorbed by both sides; they will have to make changes and companies will have to make changes,” said Essaides. “But I think some corporates are concerned that the banks are passing along that cost to them, rather than cutting back internally so that they can still be profitable even though they need to maintain a higher level of capital.”

The guide notes that many corporates feel their banks have already included the higher cost of capital in their models and anything further is unwarranted. “If you’re a Canadian banker, your first assumption is to pass it along to the customer. It may not necessarily happen. Canadian banks don’t have a full appreciation of that,” said a treasurer quoted in the guide.

Additionally, the banking sector in Canada is far less competitive than in a country like the U.S.—Canada only has five major banks. The banks wield tremendous power and there might be little corporates could do if costs increase. “Given [the banks’] history and sense of entitlement they will try to push forward increased regulatory cost of capital onto their customer base directly,” said another treasurer.

Some corporates do not believe the requirements will have a significant impact on their banking costs, but Essaides believes this view is misguided. “I don’t think that we’ll necessarily see a huge difference in prices of credit lines,” she said. “But there will be a significant difference in pricing for letters of credit and derivatives, because of the way that the new regulations force banks to calculate capital ratios and credit valuation adjustments.”

Some corporates AFPC spoke with see themselves only incurring small incremental costs, because Canadian banks are among the best capitalized in the world. “The Canadian banks are well up on the scale of financial health. Basel III would not have a huge effect on them,” said one assistant treasurer.

The guide notes that the different views among corporates are partially the result of banks’ failure to fully communicate what lies ahead under Basel III. Essaides noted that corporates should be making a major push to get all the information they can out of their banking partners. “I think the fact that [corporates] demanded this guide is a sign that they are becoming less patient with the slow flow of information” from banks, she said.
 
Banks themselves are still figuring out the rules. But they are also spending a lot of time and energy sorting out their internal procedures, Essaides added. “They’ve focused a lot of their communication internally first,” she said. “They have to run through many presentations to the business units explaining what this means for product profitability and customer profitability. So they haven’t gotten to the stage where they’re speaking clearly with their customers.

“But I think companies definitely need to make a bigger effort to ask their banks specifically, ‘What are you going to do? What do you see as the biggest impact of all this? What are your plans?’ And sometimes the answer is, ‘We don’t know.’ But at least by talking to the banks you can see that a lot of them have a pretty good sense of what is generally going to happen.”

Download Canada First: Basel III’s Implications for Canadian Treasurers here.

A longer version of this article will appear in the January/February edition of Exchange.