The impact of financial regulation on business models of cooperative banks in Germany

A number of studies have highlighted the potential negative implications of stronger financial regulations, however, only a few studies have attempted to quantify the regulatory impact of Basel III on profitability. Regulation has specific costs, as well as benefits, for any economy. Likewise, it has consequences for the cost of capital of banks, as well as their interest margin. The analysis provided in this article has calculated the implications of Basel III on the profitability of banks and found that they range between 14 and 111 basis points – in case no countermeasures are taken by the respective banks. In addition, this article looks at the implications of interest rate risks on banks, and the potential negative impact on bank capital ratios in the case of interest rate risk integrated in the capital requirements of pillar 1 of Basel III. Consequently, using the balance sheet data from 756 cooperative banks in Germany, we have examined the implications of the “Basel interest rate shock,” where a sudden parallel shift in the yield curve of 200 basis points happens. The three test calculation scenarios assume the following: (1) a full implementation of Basel III without the integration of interest rate risks in the banking book of pillar 1, (2) analysis of theoretical maturities for the calculation of the interest rate risk, and (3) using legal contract terms and maturities as the basis for calculation of the interest rate risks. The results of the study show that in a scenario where the legal contract term was used, 5.3% of the analyzed group did not reach the minimum ratio for core capital of 4.5%, and another 46.6% of the banks would be below the 7% ratio and, therefore, would be limited in their earnings distributions; 86.9% of the cooperative banks in the analyzed group would fall below the threshold of 10.5%. We reach the conclusion that financial regulation should not follow the rule of “one-size-fits-all” because the business models of small cooperative banks in Germany are different to those of major global banks. A global or European uniform regulation for all banks, neglecting size and business model, could also jeopardize the culture of fixed interest financing for mid- and long-term loans for German SMEs.