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Banking in the age of Basel III

Banking in the age of Basel III

Sentinel Digital DeskBy : Sentinel Digital Desk

  |  5 Sep 2017 12:00 AM GMT

By Dr B K Mukhopadhyay

What’s in store – writing on the wall? In fact, in this fast changing world of innovention [innovation + invention] the entire banking world has been witnessing such things which were hitherto not much in existence. The modern banking industry has brought greater business diversification. Banks in the developing world also like the industrialized counterpart have been entering into investments, underwriting of securities, portfolio magement and the insurance businesses, among others. In fact since the beginning of the 21st century, the biggest banks in the industrial world have become complex fincial organizations that offer a wide variety of services to intertiol markets and control billions of dollars in cash and assets.

The global view

Global banking regulators rightly observe that the world’s largest banks have already met the elevated capital standards set after the 2008 fincial crisis - nearly five years before they fully take effect in 2019.

At the end of 2016 - for the fifth year running - Industrial and Commercial Bank of Chi (ICBC) was the world’s biggest bank as measured by tier-1 capital (mostly retained earnings and common stock), according to The Banker. Chinese and American banks again domite the top ten: in the only change from last year’s ranking, Bank of America reclaimed the fifth place it lost to Agricultural Bank of Chi in 2015. Chi’s banking market remains the world’s biggest by assets and tier-1 capital; last year it further strengthened its lead over America. Growth in both countries, however, was driven by second-tier banks; Chi’s big-four lenders may be reaching their size limit.

In the age of Basel III

Along with capital levels, Basel III established several measures of funding, including a liquidity coverage ratio [LCR] and the net stable funding ratio [NSFR]. The LCR is a measurement of whether banks have enough cash or assets easily convertible to cash on hand to meet their needs for 30 days under a stressed scerio, such as a fincial crisis.

Incidentally, it may be mentioned here that Tier 1 capital is the type of funding that is ‘best able to handle an economic shock, with common equity and cash reserves being the most favored version of such funding’. Basel III called on banks to have a minimum 4.5 percent Tier 1 capital ratio - but also set a higher target of a 7 percent ratio. Fincial institutions deemed to be ‘Global Systemically Important Banks’ [G-SIBs] are also required to maintain an additiol level of capital [known as a surcharge].

Under the Basel III standard, banks are to meet - 60 percent of the requirement by the start of 2015 - rising to 100 percent by 2019. Some regulators [such as the Federal Reserve], imposed their own more aggressive timelines for compliance in rules derived from the accord. The Basel Committee released a revised version of the NSFR proposal in October, 2014 and the Fed and other U.S. banking regulators, among other leading economies, were at work on implementing rules for the banks they supervise.

The bulk of that improvement came from the European banking sector. The Basel Committee also found increased compliance with the net stable funding ratio, a requirement that forces banks to hold sufficient cash or assets that can be quickly turned into cash to cover their potential losses over the course of a year.

Heavy tasks ahead

Though it remains difficult to parse future economic trends, yet no global bank can afford to sit idly by and simply hope to be able to react to future changes. Rather, in place of that based on the functioning of global banking sector of yesterday and today, one can alyze the current situation and make logical deductions about how the banking landscape will shift tomorrow. Two and two not always make four in the business world!

Supported by the latest technology, banks are working to identify new business niches, to develop customized services, to implement innovative strategies and to capture new market opportunities. With further globalization, consolidation, deregulation and diversification of the fincial industry, the banking sector will become even more complex.

While over the past decade there has been an increasing convergence between the activities of investment and commercial banks, because of the deregulation of the fincial sector, today, some investment banking [that covers an array of services from asset securitization, coverage of mergers, acquisitions and corporate restructuring to securities underwriting, equity private placements and placements of debt securities with institutiol investors] and commercial banking institutions [banking that covers services such as cash magement (money transfers, payroll services, bank reconcilement), credit services (asset-based fincing, lines of credits, commercial loans or commercial real estate loans), deposit services (checking or savings account services) and foreign exchange] compete directly in money market operations, private placements, project fince, bonds underwriting and fincial advisory work. Taken together, these changes have made banks an even more important entity in the global business community on the one hand, while on the other the risks dimensions have leapfrogged.

Risk is where the business is

Undoubtedly, today, the main function of any bank would continue to be risk magement. Banks have to adopt appropriate risk magement approach to maximize shareholder value / net value and to conform to the Central Bank’s guidelines. Again, the adoption of ALM and diversification of activities to earn fee income resulted in the assumption of risks which had to be hedged by derivatives. Since major banks are foreign exchange dealers, exchange risk and interest risk have to be covered. Again, derivatives themselves carry a lot of risk which has become a major concern of regulators.

Perform or perish

Especially for the small banks [in public sector too] the need is there to better operatiol performances. One of such vital areas has been comparatively high cost-income ratio. The cost-income ratios of some of the small banks are still unfavourable [quite high] compared to the biggies and thus these small banks must improve upon by increasing the business rapidly.

As profitability is one of the prime business evaluation indexes, simultaneously with other vital indicators like: strength and soundness, credit quality, growth and efficiency, betterment of cost-income ratio – one of the top sub-criterion in the are of profitability - occupies the central place. Efforts must be on to move towards that direction so that within a reasoble time the ratio becomes nearer to the peer group level.

The betterment, in turn, is hinging upon two vital wings – minimization of cost [interest plus operating] and maximization of income [interest plus non-interest]. The first area has been on the rise due to exterl factors as well as interl factors, while the second area reflects better picture emerged from the segments.

Filly, what is written on the wall? The banking sector is set to consolidate globally with only five or six lenders emerging as major players [viz. HSBC, Deutsche Bank, Lloyds’ Bank, etc]. As per the Deutsche Bank recent assessment, for example, one European bank will remain among the global majors after the consolidation process and that must be Deutsche Bank [in terms of market value, it ranks 24th among the global fincial institutions].There are reasons to keep faith on such assessments - the anticipation of consolidation of large banks around the world in the coming years and only five or six banks will emerge at the end as major global players.

So, ultimately the challenge before all is maging the change, mage the risk with speed and stability.

Dr Mukhopadhyay, a noted Magement Economist and an Intertiol Commentator on Business and Economic Affairs, can be located at m.bibhas@gmail.com

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