Overview of Basel III Regulations

I intend to zoom in on the main axes of this new regulation, and on the main changes Basel III will bring to banks. Let's start with the first part. Basel III, as the name already indicates, continues on from Basel II. Basel II was mainly focused on the level of capital. When lending money, banks engage in activities bearing some level of risk. For this, Basel II presupposes that some risks come with lending, and part of the capital has to be set aside to cover these risks. To illustrate this, we will take BNP Paribas Fortis as an example, using some round numbers to render the comparison somewhat easier. Let's use 200 billion of loans as the starting point. Basel II states that some risks are associated with those loans. and Basel III continues this reasoning. This risk is not equal to all of those loans. For this, the loans are weighted in order to arrive at the total amount of risk-weighted assets. Returning to the 200 billion of loans, some are weighted at 100%, some at 50% or less. In this instance, 200 billion of loans give us a total of 100% of the risk-weighted assets. 100 billion of risk-weighted assets. Basel II told banks to set aside 2.5% on the risk-weighted assets, or 2.5 billion in this case. Basel III is using the same concepts, but imposes not 2.5%, but 7%, or even more, depending on the nature of the activities and the type of bank. This was the first axis. leading to a considerable increase in the required capital for banks. The second element, Basel III adds, relates to the size of the balance sheet. In the past years, we have seen balance sheets of banks growing significantly. Basel III insists on limiting this and even stimulates banks to take initiatives to reduce them. The way to impose this is by putting a limit on the size of the activities a bank can develop, compared to its own capital. For this, a leverage ratio has been developed. The third element added by Basel III, and probably the most important one, is liquidity. Liquidity is represented by this bucket. The bucket is not filled up with water, but it represents liquidity. So it contains euros and cents. What is liquidity to a bank? A bank receives deposits and grants loans. Every day, the bank disposes of a certain level of cash through its activity of collecting deposits and by providing cash to clients while granting loans. It's very likely the bank will not be in equilibrium at the end of the day. If it has more deposits than loans, it will deposit part of them with another bank. If it has granted more loans than it received deposits, it will go for a loan with another bank via the so-called interbanking market. Of course, it's key for a bank to have equilibrium between its loans and deposits for each period of time. To be sure such equilibrium will exist, Basel III has developed a specific regulation. Before zooming in on this, I will first explain the metaphor of the bucket used in this film. As we saw, The bucket fills up with euros and cents. So each time the bank receives a deposit, the bucket will fill up. Each time the bank grants a loan, some liquidity will leave the bucket. Why? Because the related cash will be with the corporate client, with the individual, or with the person who sold a good to this individual. Still, another aspect requires an explanation before we can tackle the regulation itself. The in and outgoing cash flows are very typical to each bank. I can explain this as follows. A savings bank is specialized in the collection of deposits. Its bucket will fill up at high speed and can even have an overflow. At the other end of the spectrum, a merchant bank specialized in lending activities to large corporates will see its buckets emptied at high speed. It's mainly the speed of the bucket filling up and emptying that is typical for each bank. For this, Basel III imposes standardized stress tests on all banks. In fact, Basel III compels banks to have sufficient liquidity available during a period of 30 days of stressed conditions. In normal conditions, one can expect a loan to be reimbursed completely at its maturity date. This is not the case during the stress test window of 30 days. Then only 50% serves to reimburse the bank, and the bank has to inject the other 50% in the economy by granting new loans. So for loans at maturity, 50% leaves the bank again. Let's have a look at the treatment of deposits. The first category is deposits from individuals and from small and medium-sized companies. Basel III states they leave the bank at 5% or 10%. So, during the 30-day stress period, 5% or 10% of those deposits will basically walk out the door. For deposits received from banks, the runoff percentage is at 100%, meaning they will leave completely before the end of the stress test. Of course, a third category exists, the one relating to deposits from corporates. Here, a very important notion is introduced by Basel III. 25% or 75% of the deposits of corporates will leave, depending on the existence or non-existence of an operational relationship between the bank and the corporate. In other words, if a bank has 10 billion corporate deposits and an operational relationship with these clients, 2.5 billion will be lost. I suppose, no operational relationship exists. The bank might even lose 7.5 billion of these deposits. The result is a 5 billion difference in the stress test for Basel III. We'll come back on this Basel III tendency to guide banks towards more traditional activities. I've explained that at all times enough liquidity has to be available to comply with the stress test. This will put pressure on the net results. Remember also that the required increase in the capital must be set aside. So we are dividing something becoming smaller by something becoming larger. This leads to a reduction in return on equity for banks. This is a very tangible Basel III impact on banks. The primary challenge to a bank is the managing of the equilibrium between loans and deposits. This is a fundamental daily challenge that will drive the banks. As I have explained, banks face a profitability challenge. Revenues from cross-selling will be welcome, and on top of this, cross-selling will be required to manage the equilibrium loans-deposits. However, this cross-selling also leads to more operational intimacy, the kind of operational relationship we referred to earlier. So, while managing the balance between deposits and loans, cross-selling will also be key. The operational intimacy this will bring will help to retain the required liquidity levels for the stress test. So, this is very fundamental to the required calculations for Basel III, as well as for the continuity of the bank. This leads us to our statement that banks have to have complementary activities to the business of granting loans and collecting deposits. Cash management is a good example. Cash management is key in this context. Factoring is also a complementary activity. The former Fortis factoring entity has now returned to BNP Paribas Fortis to become part of the service offered to our clients. With what you have just seen, I hope I have provided you with an overview of what Basel III is all about, how it impacts banks and the shifts it will bring to the interaction with their clients. This means that banks will work on a closer relationship with their clients and put more emphasis on traditional banking activities. Thank you all for your attention.

Basel II was mainly focused on the level of capital. When lending money, banks engage in activities bearing some level of risk. For this, Basel II presupposes that some risks come with lending, and part of the capital has to be set aside to cover these risks. To illustrate this, we will take BNP Paribas Fortis as an example, using some round numbers to render the comparison somewhat easier. Let's use 200 billion of loans as the starting point.

Basel II states that some risks are associated with those loans. and Basel III continues this reasoning. This risk is not equal to all of those loans.

For this, the loans are weighted in order to arrive at the total amount of risk-weighted assets. Returning to the 200 billion of loans, some are weighted at 100%, some at 50% or less. In this instance, 200 billion of loans give us a total of 100% of the risk-weighted assets.

100 billion of risk-weighted assets. Basel II told banks to set aside 2.5% on the risk-weighted assets, or 2.5 billion in this case. Basel III is using the same concepts, but imposes not 2.5%, but 7%, or even more, depending on the nature of the activities and the type of bank.

This was the first axis. leading to a considerable increase in the required capital for banks. The second element, Basel III adds, relates to the size of the balance sheet. In the past years, we have seen balance sheets of banks growing significantly. Basel III insists on limiting this and even stimulates banks to take initiatives to reduce them.

The way to impose this is by putting a limit on the size of the activities a bank can develop, compared to its own capital. For this, a leverage ratio has been developed. The third element added by Basel III, and probably the most important one, is liquidity. Liquidity is represented by this bucket. The bucket is not filled up with water, but it represents liquidity.

So it contains euros and cents. What is liquidity to a bank? A bank receives deposits and grants loans.

Every day, the bank disposes of a certain level of cash through its activity of collecting deposits and by providing cash to clients while granting loans. It's very likely the bank will not be in equilibrium at the end of the day. If it has more deposits than loans, it will deposit part of them with another bank.

If it has granted more loans than it received deposits, it will go for a loan with another bank via the so-called interbanking market. Of course, it's key for a bank to have equilibrium between its loans and deposits for each period of time. To be sure such equilibrium will exist, Basel III has developed a specific regulation.

Before zooming in on this, I will first explain the metaphor of the bucket used in this film. As we saw, The bucket fills up with euros and cents. So each time the bank receives a deposit, the bucket will fill up.

Each time the bank grants a loan, some liquidity will leave the bucket. Why? Because the related cash will be with the corporate client, with the individual, or with the person who sold a good to this individual.

Still, another aspect requires an explanation before we can tackle the regulation itself. The in and outgoing cash flows are very typical to each bank. I can explain this as follows. A savings bank is specialized in the collection of deposits. Its bucket will fill up at high speed and can even have an overflow.

At the other end of the spectrum, a merchant bank specialized in lending activities to large corporates will see its buckets emptied at high speed. It's mainly the speed of the bucket filling up and emptying that is typical for each bank. For this, Basel III imposes standardized stress tests on all banks. In fact, Basel III compels banks to have sufficient liquidity available during a period of 30 days of stressed conditions.

In normal conditions, one can expect a loan to be reimbursed completely at its maturity date. This is not the case during the stress test window of 30 days. Then only 50% serves to reimburse the bank, and the bank has to inject the other 50% in the economy by granting new loans. So for loans at maturity, 50% leaves the bank again. Let's have a look at the treatment of deposits.

The first category is deposits from individuals and from small and medium-sized companies. Basel III states they leave the bank at 5% or 10%. So, during the 30-day stress period, 5% or 10% of those deposits will basically walk out the door. For deposits received from banks, the runoff percentage is at 100%, meaning they will leave completely before the end of the stress test. Of course, a third category exists, the one relating to deposits from corporates.

Here, a very important notion is introduced by Basel III. 25% or 75% of the deposits of corporates will leave, depending on the existence or non-existence of an operational relationship between the bank and the corporate. In other words, if a bank has 10 billion corporate deposits and an operational relationship with these clients, 2.5 billion will be lost.

I suppose, no operational relationship exists. The bank might even lose 7.5 billion of these deposits. The result is a 5 billion difference in the stress test for Basel III.

We'll come back on this Basel III tendency to guide banks towards more traditional activities. I've explained that at all times enough liquidity has to be available to comply with the stress test. This will put pressure on the net results. Remember also that the required increase in the capital must be set aside.

So we are dividing something becoming smaller by something becoming larger. This leads to a reduction in return on equity for banks. This is a very tangible Basel III impact on banks.

The primary challenge to a bank is the managing of the equilibrium between loans and deposits. This is a fundamental daily challenge that will drive the banks. As I have explained, banks face a profitability challenge.

Revenues from cross-selling will be welcome, and on top of this, cross-selling will be required to manage the equilibrium loans-deposits. However, this cross-selling also leads to more operational intimacy, the kind of operational relationship we referred to earlier. So, while managing the balance between deposits and loans, cross-selling will also be key. The operational intimacy this will bring will help to retain the required liquidity levels for the stress test. So, this is very fundamental to the required calculations for Basel III, as well as for the continuity of the bank.

This leads us to our statement that banks have to have complementary activities to the business of granting loans and collecting deposits. Cash management is a good example. Cash management is key in this context. Factoring is also a complementary activity. The former Fortis factoring entity has now returned to BNP Paribas Fortis to become part of the service offered to our clients.

With what you have just seen, I hope I have provided you with an overview of what Basel III is all about, how it impacts banks and the shifts it will bring to the interaction with their clients. This means that banks will work on a closer relationship with their clients and put more emphasis on traditional banking activities. Thank you all for your attention.

Transcript for:Overview of Basel III Regulations

Transcript for:
Overview of Basel III Regulations