Bank of Canada Puts Price Tag On Basel III

According to analysis done by the Bank of Canada and the Basel Committee, the higher capital requirements for banks as agreed in the Basel III agreement, will reduce the economic growth in G-20 countries by 8,8%. In addition will the transition period of four year reduce the groups average GDP by 1.1%. However, governor Mark Carney of Bank of Canada argues that the long term benefits can be far greater if more regulations are added.

“The only benefit quantified is the gains to GDP resulting from a reduced probability of future financial crises.”

Mark Carney

More and more details about the central bank‘s Basel III agreement are surfacing. The new capital requirements that are scheduled to be implemented over the next eight years will be no problem for most banks, but for the rest of us will it probably make the recovery period longer and harder.

The full text of governor Mark Carney’s speech at the German Bundesbank’s annual meeting in Berlin this week is just  released by the Bank of International Settlements.

It’s quite an interesting read.

Together with the Basel Committee, Bank of Canada have estimated both the cost and the benefits from raising the capital requirements in the financial sector, and highlights the long term benefits that are assumed to be a 30% – 40% increase in the G-20 nations GDP.

Exactly how long the “long term” is, is not said.

But what’s perfectly clear is the the short term cost – the implementation period – will be substantial.

According to the analysis, the first 2% raise in the banks capital ratio will lead to an average fall in the G-20’s GDP by 5% (about 1,7 trillion euro).

The next step, up to 4%, will reduce the average GDP by 8,8% (almost 3 trillion euro).

In addition, the transition cost are estimated to an equal of 1,1% of GDP (around 370 million euro).

Filling up the banks will not only have a negative impact on economic growth for the rest of this decade, it will also cost us another 5 trillion euro.

Mark Carney

In this analysis banks are assumed to” fully pass on the costs of higher capital and liquidity requirements to borrowers rather than reducing their current returns on shareholders’ equity or operating expenses, such as compensation, to adjust to the new rules,” Mr. Carney points out.

Adding that the higher capital and liquidity requirements are “assumed to have a permanent effect on lending spreads, and hence on the level of economic output. No allowance is made for the possibility that households and firms may find cheaper alternative sources of financing.”

Before he makes the following punchline:

“The only benefit quantified is the gains to GDP resulting from a reduced probability of future financial crises.”

And that is 10 trillion euro, according to the analysis – long term, of course.

There Will Be More

Governor Carney’s speech also reveals a broad set of measures that currently are under consideration by the central bankers.

Banks can follow several strategies to meet regulatory demands for higher capital requirements, besides passing the cost on to the customers,  governor Carney points out.

“Consider the alternative. If banks were to reduce personnel expenses by only 10 per cent (equal to a 5 per cent reduction in operating expenses), they could lower spreads by an amount that would completely offset the impact of a 2-percentage-point increase in capital requirements,” he says.

The idea behind the Basel III arrangement is that higher capital ration will lead to less market volatility, and thereby increase economic growth.

“A much more significant impact can be expected from other macroprudential instruments under consideration. These include varying loan-to-value and other credit terms in mortgage markets, adopting through-the-cycle margining in core funding markets, and the introduction of countercyclical capital buffers,” the BoC governor told the audience in Berlin.

Also; “there is a range of initiatives under consideration to reduce moral hazard, including new frameworks for the effective resolution of banks, more intensive supervision of key institutions, the introduction of contingent capital, and the creation of more robust infrastructure.”

And:; “the totality of the G-20 reforms has the potential to shift the balance between resiliency and competition. By creating a system that is robust to the failure of a single firm, reforms could increase the competitive intensity in the financial services sector.”

According to Mr. Carney, the fundamental objective of the reforms is to create a system that efficiently supports economic growth while providing financial consumers with choice.

“This means ensuring that individual financial institutions are stronger and less systemically important, that more options for liquidity are available in all states of the world, and that the new measures promote competition.”

So, just to make it perfectly clear; the goal of this reform is NOT to prevent another economic crisis, just to reduce their frequency.

“A fully risk-proofed system is neither attainable nor desirable. The point is not to pile up so much capital in our institutions that they are never heard from again, either as a source of instability or of growth. The challenge is to get the balance between resiliency and efficiency right, governor Mark Carney of Bank of Canada concludes.

Here’s a copy of the transcript.

Related by the Econotwist:

Central Bankers Announces A Higher Form Of Capital Standards

Bankers Hail The New Basel III Regime

Will Basel III Crush the Global Economy?

Central Bankers Propose To Propose Repo Clearing Arrangements

In The Mind On Jean-Claude Trichet

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