Basel III Regulation Overview

Introduction to Basel III

• Basel III builds on the principles of Basel II.
• Basel II focused on capital levels required for banks.

Key Elements of Basel III

1. Increased Capital Requirements

• Capital Requirement Increase:
  • Basel II required banks to set aside 2.5% on risk-weighted assets (RWAs).
  • Basel III increases this to 7% or more, depending on the bank's activities.
• Risk-Weighted Assets (RWA):
  • Total of 200 billion in loans results in 100 billion of RWAs after weighting (some at 100%, some at 50%).

2. Balance Sheet Size Limitation

• Leverage Ratio:
  • Basel III limits the size of a bank's activities relative to its capital to control balance sheet growth.

3. Liquidity Requirements

• Liquidity Management:
  • Banks must manage their liquidity effectively to maintain equilibrium between deposits and loans.
• Liquidity Bucket Metaphor:
  • Represents cash flow: deposits fill the bucket, loans empty it.
• Stress Tests:
  • Basel III mandates tests for sufficient liquidity over a 30-day stressed period.

Cash Flow Dynamics

• Loan Repayment during Stress Tests:
  • Typically, only 50% of loans are expected to be repaid during stress conditions.
• Deposit Runoff Rates:
  • Individual and SME deposits: 5% to 10% runoff during stress.
  • Deposits from banks: 100% runoff.
  • Corporate deposits: 25% to 75% runoff based on the operational relationship.

Impact on Banks

• Profitability Challenges:
  • Increased capital requirements and liquidity constraints pressure net results.
  • Return on equity is reduced due to heavier capital demands.

Cross-Selling and Operational Intimacy

• Cross-selling becomes essential to manage loan-deposit equilibrium.
• Enhances operational intimacy with clients, helping retain required liquidity levels.

Complementary Banking Activities

• Banks must engage in activities beyond lending and deposits.
• Examples Include:
  • Cash management.
  • Factoring services (e.g., Fortis factoring returned to BNP Paribas Fortis).

Conclusion

• Basel III promotes a closer relationship between banks and their clients, emphasizing traditional banking activities.
• Banks must adapt to meet the regulatory requirements while maintaining profitability.