It’s been a great day for the financial industry. The announcement of the new rules on capital requirements by the Basel Committee Banking Supervision – also known as Basel III – was met with standing ovations from a number of industry representatives, Monday. The financials were also the major mover in today’s stock trading. Leading institutions like the US Federal Reserve, ECB, Goldman Sachs and Bank of America have all made statements, praising the new rules that will not be fully implemented until 2019.
“This action, in combination with the agreement reached at the July 26, sets the stage for key regulatory changes to strengthen the capital and liquidity of internationally active banking organizations in the United States and around the world.”
Today’s rally in financial stocks all over the world is most of all a relief rally. The result of the Swiss banking committee’s work with new requirements is precisely as the industry leaders expected. Not too strict, and with plenty of time to shore up the minimum of needed cash. But the best of all: We have now official, global laws that acknowledge the too-big-to-fail principal and makes sure they will be rescued if another crisis occur in the coming years.
Most of the big players in the financial sector gained between 3% and 6% in Monday’s stock trading.
Deutsche Postbank, however, fell almost 8% after Deutsche Bank AG offered between 24 euros and 25 euros a share to increase its stake in the lender. Deustche Bank, Germany’s largest lender, gained 1.7 percent after saying it would raise at least 9.8 billion euros ($12.6 billion) in its biggest-ever share sale to buy Postbank and meet the stricter capital rules.
The German banking association is also the only member of the Basel Committee who have made critical remarks on the new Basel III retirements.
A Significant Step
“The US federal banking agencies support the agreement reached at the September 12, 2010, meeting of the G-10 Governors and Heads of Supervision (GHOS). This action, in combination with the agreement reached at the July 26, 2010, meeting of GHOS, sets the stage for key regulatory changes to strengthen the capital and liquidity of internationally active banking organizations in the United States and around the world,” the FED write in a statement.
“The agreement represents a significant step forward in reducing the incidence and severity of future financial crises, providing for a more stable banking system that is less prone to excessive risk-taking, and better able to absorb losses while continuing to perform its essential function of providing credit to creditworthy households and businesses.”
“Today’s agreement represents a significant strengthening in prudential standards for large and internationally active banks,” Ben Bernanke & Co points out.
Calculations done by Zero Hedge show that the the 3.5% minimum common equity ratio by 2013 means the leverage will be just under 30 times – or enough for every bank in the world to pull a Lehman, which blew itself up at roughly the same leverage.
(In comparison; US banks had a leverage of “only” 20% before the crisis hit).
“All who think European banks will survive through 2019 with this type of leverage should look into investing in these great companies: New Century Financial, Countrywide, and IndyMac,” Tyler Durden at Zero Hedge comments.
But who cares about old trivial stuff like that?
“We think the numbers are in line with prior market expectations and the implementation period long enough and therefore not at all alarming. In fact, our initial read of the impact on banks is positive. Credit investors should look forward to a number of capital risings from European banks, as looks like is already happening. This should be very bullish for bank spreads, in our view,” BoA says in their happy greetings.
Here are some other highlights – taken completely out of context, of course:
“The Committee believes that large banks will require 2a significant amount of additional capital to meet these new requirements.” Oddly, they think that smaller banks already meet them. We’d not be sure that this is true, at least in Europe.”
“This looks quite bullish for us for calls of Tier 1’s, especially those after 2013. In the meantime, note that we have no concrete agreement on the new format of new bank capital instruments.”
“Note too that the government capital injections, even if they don’t meet the new format, are to be grandfathered to 2018, giving banks plenty of time to adjust.”
“We had thought that some kind of countercyclical buffer would have been built into provisioning (like in Spain) but it looks like its just being done via higher equity.”
“No change to the overall level of capital, but it’s hard to see anything other than a major de-emphasising of anything that isn’t common – as we were expected.”
Small Macro Risks
Also Goldman Sachs are pleased with Sunday’s Basel agreement, but perhaps a bit more uncertain about what the impact will be, if any.
“There are two crucial questions when trying to assess the macro-economic implications of the new regulatory environment for banks. 1) by how much will banks have to raise their capital on the back of these changes. 2) Will lending become more costly/rationed and what are the growth implications of this. Our banks team estimates that only 4 banks among the 47 European banks covered have a core tier 1 ratio of below 7% by 2012. While this looks reassuring, it is less straightforward, however, to assess what the figure for the whole banking sector – including the non-public parts of the banking sector – looks like. The head of the Dutch central bank Wellink is cited this morning as saying that banks would need “hundreds of billions” to meet new capital requirements, though the economy, according to Wellink, will not be impacted by this. It is not clear where these numbers are coming from and other ECB board members have not mentioned any figures when commenting on the new capital rules,” Goldman Sachs analyst Dirk Schumacher writes.
“Assuming that the banking sector as a whole would currently show a 4% ratio, as required under the old Basel II regime, the overall growth impact looks manageable.”
“Implementation will start in 2013 and will have to be finished by 2018. This should give banks sufficient time to adjust, arguing for an overall small macro impact of the new capital regime.”
The US investment firm, Credit Sights, highlights that it is impossible to actually do any practical bank-by-bank analysis due to “the long lead-in period, lack of disclosure, and the remaining uncertainties over changes to certain risk weightings and allowable capital instruments, while new criteria are still being finalized.”
But that doesn’t stop the European bank analysts from analyzing themselves straight into a new golden bank area.
Here are some more happy thoughts, as collected by The Guardian:
Chris Weston at IG Markets: “Global banks will like the news that they have been given an extended period [to comply with the rules] and the fact that they’re not going to have to rush to raise capital.”
Gary Jenkins, analyst at Evolution Securities: “All other things being equal, an increase in capital for the banking sector is of course good news for bondholders and the combination of the new regulatory regime and the stress tests does seem to have restored some confidence in the sector as evidenced by the recent amounts of bond issuance.”
Financial analysts at Oriel Securities: “The final outcome on Basel III determined by regulators over the weekend looks positive for UK banks. UK banks at face value appear to comply well with the new guidelines.”
Eleonore Lamberty, analyst at ING Credit Research: “Currently, the majority of European banks will have no problem to meet the new requirements. For the handful of banks that would find it more difficult, the very lengthy implementation period ensures that any capital shortfalls can be addressed, possibly through retained earnings. The industry-wide expectation of significant capital-raising exercises has hereby become much less compelling.”
Joseph Dickerson at Execution Noble: “We believe that the market will be punitive to banks which don’t meet a core tier 1 ratio of 9.5% – 10% under new requirements by 2012. While this is somewhat arbitrary timing, our research has shown that the market is already applying a multiple discount to banks with weaker capital positions, and almost all of the banks in our coverage classify as “systemically important”.
And The Winners Are….
Andrew Lim, analyst at Matrix Corporate Capital, is even sure who’s going to be the winners and losers in the new capital regime.
(Quite obvious, really, since they are owned and controlled by their governments):
“Even without taking into account a phasing-in period, the large-cap commercial banks exceed the minimum common equity ratio (including conservation buffer) of 7% by 2012. We see this as a significant positive for the sector on a number of fronts,” Mr. Lim writes.
• This sets the stage for a capital return to shareholders, via special dividends and accretive buybacks.
• Unlike the bank stress tests, we see the minimum capital ratios as reassuringly onerous.
• For the first time, the capital strength of the sector can be compared on a like-for-like basis. We believe the market will appreciate the increased transparency that will come to the sector, which will lead to higher ratings for the banks (as was the case 30 to 40 years ago).
• The return of excess capital might be limited by the implementation of a countercyclical buffer on top of the conservation buffer. The implementation of this is unclear at present. If applied in its most onerous form, we believe only the Nordic banks will have what could strictly be termed excess capital.
The Nordic banks (DnB NORD, Handelsbanken, and Nordea) are in the strongest relative position. We believe these banks will be in the best position to consider returning the most amount of capital to shareholders, and will be the earliest to do so as well.
Lloyds looks to us likely to have one of the strongest common equity ratios by 2012. It should be noted that this is due to its strong organic capital generation, combined with its plan to reduce RWA (ie shrink the balance sheet). Lloyds does not currently have a strong Basel III common equity ratio by our analysis (unlike the Nordic banks), so the market must have conviction that Lloyds’ management can deliver. Unlike the Nordic banks, Lloyds will not be in such a privileged position to return capital as early and must wait until it generates sufficient capital.
The Italian banks UniCredit and Intesa and Spain’s BBVA are in the weakest relative position, having common equity ratios which are just above 7%. We do not think they will seek to raise capital, since our analysis does not include the phasing-in period. However, they do not look like they will have excess capital by our analysis.
Santander, HSBC, Barclays and Standard Chartered appear by our analysis to be average compared to the peer group having common equity ratios of 8%-9%. These banks are comfortably above the minimum of 7%. They will be in a position to return some excess capital to shareholders in our opinion, but are not likely to do so as quickly (or as much) as for the Nordic banks.
Unfortunately, it seems like Andrew Lim at Matrix Corporate Capital do not.
He mention DnB NORD as one of the best positioned Nordic banks.
But the fact is that DnB NORD is a Baltic zombie bank, owned (currently 51%) by the Norwegian bank DnB NOR.
Surely, just a little mix-up. Nothing to worry about. Everybody’s fine!
(At least until 2019..)
Related by the Econotwist:
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- Bankers agree on Basel III rules to raise capital reserves (newstatesman.com)
- ECB Wellink: Very Positive On Basel III Accord (forexlive.com)
- Global Deal Reached on ‘Basel III’ Finance Reforms (dailyfinance.com)
- ECB’s Nowotny: Basel III To Mean Fewer Suspect Loans: Press (forexlive.com)
- Update:Germany FinMin: No Risk Of Credit Crunch Due Basel III (forexlive.com)
- Basel III: And the Biggest Winners Are . (blogs.wsj.com)
- Snap analysis: Implementation key to Basel III success (reuters.com)
- Factbox – Reaction to Basel III Bank Capital Rules (nytimes.com)