IN response to the crisis, the Basel Committee on Banking Supervision’s new proposals (Basel 3) for strengthening capital and liquidity and ensuring a more resilient banking sector were endorsed by the G-20 in Seoul. Much remains to be done to translate these measures into concrete legislation and regulation at a national level, and significant territorial differences are emerging. Nevertheless, all G-20 nations have committed themselves to adopting Basel 3 by the end of 2011. All banks need to consider what the implications might be.

The G-20 endorsed the new Basel 3 capital and liquidity requirements at its November 2010 summit in Seoul. There are many areas of detail needing further development, and worldwide debate and lobbying will inevitably continue. However, the core principles are agreed, and banks need to start planning their responses.

The key changes involve:

·      Improving the quality and transparency of banks’ capital base and tightening the definitions of Tier 1 and Tier 2 capital;

·      Improving resilience and reducing risk by specific measures on counter-party exposures; restricting dangerous levels of leverage; reducing procyclicality and encouraging the creation of countercyclical capital buffers; and

·      Introducing a minimum liquidity standard.

The enhanced capital ratios prescribed by Basel 3 will place increased pressure on compliance.

The capital ratio requirement will increase; the eligibility of capital will be tightened so reducing the amount of capital firms have to meet the required ratio; and the calculation of risk weighted assets (RWA) will change, leading to an increase for many organizations.

It is difficult to estimate the precise impact on individual firms, but a study shows that the estimated possible percentage range of increases to the RWA arising from three of the key capital changes in Basel 3, together with some estimate of the percentage range of mitigation of the potential RWA increase that many believe might occur due to firm-wide actions. In addition, firms may face shortfalls in their long-term funding needs of up to 50 percent as a result of the new net stable funding ratio (NSFR) liquidity proposals.

Despite a lack of absolute clarity over how these measures will be implemented locally, there is no time to waste. Experience from Basel 2 proved that early analysis, strategic evaluation and robust planning are all crucial to success. Firms must also remain flexible to adapt to subsequent changes and developments, with a number of other parallel policy initiatives being put in place, notably recovery and resolution plans, enhanced college of regulator arrangements and continuing uncertainty over tax.

To be continued

This article is cowritten by Jane Leach, UK head of Basel 3, KPMG in the UK; Klaus Ott, partner for financial services, KPMG in Germany; Steven Hall, director of financial risk management, KPMG in the UK; and Hugh Kelly, principal, KPMG in the US. This article was taken from the publication Frontiers in Finance,  April 2011, produced by KPMG’s Global Financial Services Practice in the UK.

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