How much is the Risk Capital Requirement of Basel III Going to Affect the Big 6?

The brainchild of certain banking regulators, Basel III is set to be imposed upon banks starting in 2013 and be fully phased in by 2019, BASEL IIII AND GDP REDUCTIONSwith the overall estimated effect on global GDP of about -0.2 percent in its initial year.  From the Federal Reserve’s and other financial regulator’s perspective, the $115 billion decrease in global output and the associated decrease in employment growth of about 6 million people worldwide is worth a purportedly safer financial system.  Whether the effect on the unemployed is worth the desire from certain regulators to control bank capital is a judgment call – what’s not a judgment call are the details of what Basel III does.  In the United States, the Federal Reserve plans on implementing Basel III pretty much as outlines in the international agreement, which has three general tenets:

  • An increase in the risk capital requirement (risk weighted assets) from 2.5 percent to greater than 7 percent, depending upon the type of risk assets;
  • Attempts to limit (and provides incentives for) banks’ balance sheets through the use of a leverage ratio; and
  • Addresses required liquidity in various ways, such as through stress testing.

This article addresses the question: how much is the risk capital requirement of Basel III going to affect the six biggest U.S. financial institutions; Wells Fargo & Company (NYSE:WFC) , Citigroup Inc. (NYSE:C) , JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp (NYSE:BAC),Goldman Sachs Group, Inc. (NYSE:GS) , and Morgan Stanley (NYSE:MS) ?

First some background – the imposition of higher risk capital details are:

  • Tier 1 Capital Ratio is raised from 4 percent to 6 percent;
  • Common equity will be raised to 82.3 percent of Tier 1 capital;
  • Imposition of a new capital conservation buffer where banks must hold a capital conservation buffer of 2.5 percent, in an attempt to minimize potential problems in periods of financial and economic stress.  The requirement bring the total common equity requirement to 7 percent;
  • Imposition of a countercyclical buffer, with a range of 0 to 2.5 percent of fully loss absorbing capital; and
  • Tier 1 common equity requirement increase from 2 percent to 4.5 percent.

To comply with the new regulations, banks likely will decrease shareholder dividends, decrease exposure to risky lending, ask investors for new cash, and hold onto future earnings.  Additionally, because of the pullback in lending to riskier sectors, borrowers are likely to see increased borrowing costs and less availability of credit.  Some of the lending is likely to shift to businesses not suffering from the regulatory burden, such as private equity firms and hedge funds.  The regulations will also likely come at the expense of profitability.

How much do banks need to come up with?  Fitch reported in May that the 29 systematically important financial institutions would BASEL III CAPITAL REQUIREMENTSlikely have to come up with something along the lines of $560 billion, of which Wells Fargo & Company (NYSE:WFC) , Citigroup Inc. (NYSE:C) , JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp (NYSE:BAC),Goldman Sachs Group, Inc. (NYSE:GS) , and Morgan Stanley (NYSE:MS) represent a good portion.

So, overall, because regulators can’t let a crisis go by without meddling, big banks are likely to see increased costs of compliance and lower return on equity, borrowers are likely to see increased borrowing costs, and the world’s economies will have around 6 million fewer employed individuals.  Now that’s a solution.