Bank capital hawks are about to bump up against the realities of politics. Basel-based standard setters are due to finalise capital adequacy reforms that banks call “Basel IV” over the next 12 months. The catch is that these tweaks to the pre-existing Basel III framework conflict with European policymakers’ growth plans.
Basel IV is needed to harmonise assessments of credit, trading and legal risks. European banks’ measurements of their risk-weighted assets – a key determinant of their capital requirements – are suspect, insofar as they sometimes produce low results and differ by jurisdiction. U.S. peers, by contrast, typically carry fuller risk-weightings on their balance sheets: they lend less to corporations and offload lower-risk mortgages to government-sponsored enterprises.
The full implementation of Basel IV may take several years. But the key question is whether European lenders, once it does kick in, will need to maintain their key common equity Tier 1 ratios at the current level of about 12 percent of RWAs.
Bank of England Governor Mark Carney’s answer to that question, for the UK at least, is no. Though he backs greater harmonisation in measuring asset riskiness, Carney argues that the UK regulator already forces banks to hold capital in anticipation of RWA reforms. So UK banks will only need to exceed a 9.5 percent common equity Tier 1 ratio under Basel IV and they won’t need new capital.
Euro zone politicians and regulators could follow Carney’s lead. European Central Bank President Mario Draghi is keen to jumpstart Europe’s securitisation market, but Basel IV could raise the relevant capital requirements by 2.2 times, according to an ISDA-led lobbying group. European politicians care more about improving the euro area’s anaemic growth rate, which the International Monetary Fund puts at just 1.7 percent in 2016.
Brussels will want a slight uptick in lending to continue. So Basel IV will be in its sights, given Barclays analysts reckon it could knock 2.2 percentage points off lenders’ common equity Tier 1 ratios. European financial services commissioner Jonathan Hill has already commissioned a review of the net effect on economic growth of various post-crisis rule changes. Its conclusion may be that Basel IV should either result in lower capital requirements, or be substantially watered down.
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