The Impact of Basel III on the Operations of Retail Banks

For many bankers, Basel III has led to a change of epoch, a change of model and for some even a change of profession. These views initially reflect the content of the Basel principles relating to two major indicators of bank stability, namely: i) solvency via the level of equity capital required, and ii) liquidity in terms of assets held. The mainstream financial press and bankers have largely discussed the impact of these measures on banking sector and the wider economy. There is no doubt that they have significant consequences on banks' activities and financing capacity. But Basel III also deals with other issues relating to the organisation and governance of financial institutions. These have been less publicised, but affect banks and the way actors operate on a daily basis as much, if not more. Basel III is a system based on three pillars. Pillar 1 is detailed throughout EU Directive CRD4. It concerns the definition of equity required to cover exposure to credit, market and operational risks. Such exposure is gauged by risk weighted assets (RWAs), and regulatory equity capital is defined differently compared to usual accounting definitions. Pillar 2 leads to the implementation of control measures of equity capital, of exposure to risks. It also includes measures to be pursued to meet these requirements. Lastly, Pillar 3 relates to market discipline, with emphasis on the information financial institutions must communicate in terms of risks. The motives of regulators in adopting Basel III clearly follow the banking crisis in September 2008: they seek to ensure that governments will no longer be obliged to protect banks from filing bankruptcy. The decisions to take capital holdings in banks in October 2008 were not understood by the public, even if the public monies committed were recovered with a profit. The political cost of such interventions has been so high that it is no longer possible for governments to find themselves in a similar situation. Public regulators have had the mission of reinforcing the safety and financial stability of banks, as well as ensuring and reinforcing the quality of internal bank controls and those carried out by national and European supervisory agencies. The European Capital Requirements Directive (CRD 4) runs to nearly 340 pages. It covers the three pillars and aims to provide precise recommendations on how banks can protect themselves against insolvency risks with sufficient levels of equity capital, and how to protect themselves against liquidity risks to prevent sudden bankruptcies. These two risks lie at the heart of regulatory concerns. But the Directive also addresses the conditions under which banks are supervised, the bodies involved in such supervision and the resolution mechanisms they put into place. Basel III therefore addresses criteria for risk and financial management as much as it stresses organisational and strategic criteria. The aim of this chapter is to review and assess the two dimensions of the consequences induced by these new texts. It seeks to see what is truly new and how financial institutions will adapt-more or less easily-to the new conditions for exercising their trade.