The Realization of the Gains of Competitive Banking - Term Paper Example

Basel III Name Course Name and Code Instructor’s Name Date Introduction The banking sector plays a significant role in modern economies. Through the sector, economies have been able to trade efficiently. For a long time, banks have been under independent domestic standards but this has changed over the recent past. According to Barfield (2011), increased advancement in technology, enhanced communication infrastructures which have minimized the cost of banking products and services and has enhanced the demand for the same, bank’s off shoring functions and the realization on the gains of competitive banking and liberalization entry into local markets, modern banks have diversified their product and service range, and extended across national borders and has been conducting business across these boundaries. This has translated into improved international banking integration within this sector, which has necessitated synchronization of banking standards globally (Doan, et al., 2006). According to Doan et al. (2006), the harmonization of standards to guide the banking sector globally has encountered varied challenges among them the formula on how to integrate local policy accountabilities with international activities, how to ensure equality and fairness among small and large banks operating internationally and to how to ensure the autonomy of the banking sector. Despite the efforts made previously by relevant stakeholders to ensure effectiveness of international set banking standards, varied gaps and loops have been noted and have therefore, obliged establishment of new global regulatory standards. The most recent global regulatory standards established are the Basel III. This report will outline the key elements of Basel III and analyze what impact the Basel III is likely to have on Australian banking especially in the area of credit risk management. Outline the key elements of Basel III Basel III is a newly established international regulatory standard on bank capital adequacy and liquidity recommended and approved by the Basel Committee on Banking Supervision as highlighted by BIS (2011). According to Barfield (2011), the regulatory framework was developed as an amendment to Basel I and Basel II used in Europe and in the US, which is perceived to be among the core contributing factors to the global financial crisis. This is because the capital adequacy regulations proposed by the two was inadequate in safeguarding banks against risks associated with securitizations, repurchase agreements and derivatives as echoed by Goeth (2010). In addition, the two regulatory frameworks paid great emphasis on capital and had no consensual accord on quantitative principles for liquidity which accelerated evaporation of liquidity in essential funding markets utilized by varied banks during the 2007 financial meltdown. The core elements of Basel III are to be implemented into national law by 2013 (Shearman & Sterling, 2011). Carmichael & Graham (2011) states that the main objectives of Basel III is to strengthen bank capital needs and establish new standards on liquidity and bank leverage which is expected to help minimize the annual GDP growth in OECD. According to (Carmichael & Graham, 2011), the Basel III will in the long run help enhance the capacity of banks to absorb shocks generated by financial and economic meltdowns, enhance risk management and control and more importantly help improve transparency and disclosures among banks. The key elements of Basel III are reforms on Capital Ratios, Leverage Ratio, Liquidity ratios and other elements such as systemically important financial institutions (SIFIs). In relation to capital base, Basel III mandates that its quality, reliability and openness be enhanced which will be achieved where Tier 1 capital will be 6% of common shares and retained earnings, Tier 2 Capital tools will be standardized while Tier 3 capital will be discarded (BIS, 2011). The regulatory frameworks requires banks to have extra capital buffers which are namely, 2.5% of compulsory capital conservation buffers and an additional capital of 2.5% of risk weighted assets throughout times characterized by increased credit growth and released during credit contraction as indicated by Shearman & Sterling (2011). Important to note is that subtractions from capital shall only be applicable to tier 1 common equity and not on overall capital. In regards to the leverage ratio element, Basel III obliges banks to have not less that a leverage ratio of 3% with two mandatory liquidity ratios with a high liquidity ratio meant to cover a bank’s total net cash flows for not less than thirty years. In addition, the bank’s assets will be handled on a non-risk adjusted basis which will lead to 33: 1 leverage ratio (BIS, 2011). BIS (2011) highlights that the liquidity coverage ratios for banks as per Basel III will be in effect from 2015 and will constitute a liquid asset buffer regulated in relation to net cash flow of not less than a month’s duration. On the other hand, the net stable funding ratio which forms the longer term liquidity, Basel III recommends banks have steady and secure funding that meets the needs of the bank for not less than year (Wittenbrink, 2011). In addition, banks are required to have available balance of steady funding that surpasses the needed amount of stable funding of not less that an year of prolonged strain or meltdown (Goeth, 2010). Extra capital and liquidity among other supervisory variables will be required which are meant to minimize pressures brought on by SIFIs or systemically important financial institutions. According to BIS (2011), minimum capital requirements are to be implemented by 2013 while conservation buffer by 2016. Supervisory monitoring for leverage ratios will ensue from 2011 with final adjustments being done from 2017. The observation period for liquidity requirements will begin in 2011 while introduction of liquidity coverage ratio will kick start in 2015 and application of Net stable funding ratio will begin from 2018 (BIS, 2011). Impact of Basel III on Australian banking especially in the area of credit risk management Shearman & Sterling (2011) notes that full implementation of Basel III will help banks strengthen their risk coverage of their capital structure, reduce procyclicality, enhance quality, alter the risks weights implemented to varied assets and banking functions and it is expected that the growth of gross domestic product will decrease annually. Economic productivity will be impacted by rising lending spreads associated with implementation of the capital requirements (BIS, 2011). According to Goeth (2010), It is expected that Basel III will be implemented consistently across the globe to ensure that there are no banks or financial institutions that establish their operations in areas with less stringent regulatory measures. Nevertheless, application of Basel III across the globe will not be alike and therefore multinational financial institutions may be compelled to adhere with stricter national timelines to which varied jurisdictions are subject to. Shearman & Sterling (2011) argues that full implementation of Basel III will not prevent disparities among capital adequacy requirements across various jurisdictions and therefore, multinational financial institutions will be obliged to follow regulations of host country regardless of their tight national capital adequacy requirements. Basel III is expected to impact on varied banking sectors across the world and its impact on Australian banking especially in the area of credit risk management will not be different. Presently, major banks in Australia already surpass the Basel III requirements for 2019, which means the impact on Basel III is most likely to be positive. With the increased amount of capital required, Australian banks will have to analyze new ways and means to continue creating value and adapting to the changes (Carmichael & Graham, 2011). More specifically, there will be change in the pricing of products and services produced by the banks, with wealth management remaining a potential ground for growth for Australian banking sector. For banks that seek to acquire competitive edge due to the changes brought by Basel III, they will be required to connect existing and future effects of the reforms to their business systems and technology structures and ensure they know the effect it will have on its processes, people and systems (Shearman & Sterling, 2011). Through the guidance of APRA in implementation of Basel III capital requirements, the rules have been applied but have retained flexibility with a minimum of Tier1 of 7% to guarantee that Australian banks are not negatively impacted by the reforms. The capital adequacy requirements will be negotiated between APRA and individual banks. Basel III is expected to impact on the lending spreads of Australian banks and influence the strategic direction banks take to ensure growth (Goeth, 2010). Basel III are expected to increase the lending spread of major banks in Australia and more importantly safeguard them from credit risks through implementation of disclosure requirements which improves transparency and credibility to both debtors and creditors (Labrosse, 2011). Australian banks will be well cushioned against any probable adverse effects associated with global financial and economic downturns and ensure through sufficient liquidity, none of them collapses or are unable to carry out their functions effectively and efficiently especially in relation to credit management as suggested by Wittenbrink (2011). Conclusion The adverse impact of the 2007 financial meltdown on the banking industry exposed the limitations and loopholes that existed in the Basel Accords I and II. As earlier discussed, Basel I and Basel II were limited in cushioning banks across the globe from collapsing or suffering from the impact of the down turn since the capital adequacy regulations proposed by the two was inadequate in safeguarding banks against risks associated with securitizations, repurchase agreements and derivatives. In addition, the two regulatory frameworks paid great emphasis on capital and had no consensual accord on quantitative principles for liquidity. The Basel III has therefore, been established as an amendment to Basel I and Basel II, the focus being mainly on cleaning up regulatory capital and enhancing risk management in the banking sector. The Basel III is intended to strengthen bank capital needs and establish new standards on liquidity and bank leverage. References Barfield, R. (2011). A Practitioners Guide to Basel Iii and Banking Reform. New York: Sweet & Maxwell, Limited. BIS. (2011). Basel Committee on banking supervision. Retrieved from http://www.bis.org/bcbs/ Carmichael, D.R. & Graham, L. (2011). Accountants' Handbook. New York: John Wiley and Sons. Doan, C., Glanville, V., Russell, A., & White, D. (2006). Greater international links in banking- challenges for banking regulation. Melbourne Money and Finance Conference. Retrieved from http://www.treasury.gov.au/documents/1190/PDF/09_banking.pdf Goeth, P. (2010). Basel III – Design and Potential Impact. London: Deloitte. Retrieved on 24th Sept 2011 from https://encrypted.google.com/url?sa=t&source=web&cd=10&ved=0CHAQFjAJ&url=http%3A%2F%2Fwww.garp.org%2Fmedia%2F529782%2Fbasel%2520iii_goeth112410.pdf&ei=XhF-TrnGE4jz-gaOhqWSDQ&usg=AFQjCNEQUKdQ22CX9AK62S2mitSvVshpvw&sig2=_PtWZqocIlDQ6fZ0GsWmnw Labrosse, J.R. (2011). Managing Risk in the Financial System. Sidney: Edward Elgar Publishing. Shearman & Sterling. (2011). the New Basel III Framework: Implications for Banking Organizations. Retrieved from http://www.shearman.com/files/Publication/f4e80b99-f0a1-4e3a-90f0-3bf21c7d0ce0/Presentation/PublicationAttachment/8d4e19cc-1ba3-4501-8fe6-63a6633d5b6b/FIA-033011-The_new_Basel_III_framework__Implications_for_banking_organizations.pdf Wittenbrink, A. (2011). Financial Regulation Through New Liquidity Standards and Implications for Institutional Banks: Basel III. Berlin: GRIN Verlag. Read More