Understand the international rules of Basel III

What is Basel III?

Basel III is a set of international banking regulations formulated by the Bank for International Settlements to promote the stability of the international financial system. The Basel III provisions aim to reduce the damage to the economy caused by banks that take excessive risks.

The problems with the original agreement became apparent during the 2007 subprime mortgage crisis. The members of the Basel Committee on Banking Supervision reached an agreement on Basel III in November 2010. Regulations were initially introduced from 2013 to 2015, but have been extended several times to March 2019 and January 2022.

Key points

  • Basel III is a set of international banking regulations formulated by the Bank for International Settlements to promote the stability of the international financial system.
  • The impact of Basel III on the stock market is uncertain, although strengthening bank supervision may be beneficial to bond market investors.
  • The ultimate impact of Basel III will depend on how it will be implemented in the future, but the ideal situation is an overall safer international financial system.

How Basel III works

Basel III and banks

Banks must hold more capital for their assets, thereby reducing the size of their balance sheets and their ability to use them. Although regulation was being discussed before the financial crisis, these events magnified the need for change.

The Basel III provisions contain several important changes in the capital structure of banks. First, the minimum amount of equity as a percentage of assets increased from 2% to 4.5%.An additional 2.5% buffer is needed to bring the total equity requirement to 7%. This buffer can be used during periods of financial stress, but banks will face limitations in their ability to pay dividends and deploy capital in other ways. Banks must implement these changes before 2019 to allow sufficient time to prevent loans from freezing suddenly as they scramble to improve their balance sheets.

Partly due to these regulations, the bank’s future profits may decrease. The 7% equity requirement is the minimum requirement, and many banks are likely to try to maintain a higher number to give themselves a cushion. If financial institutions are considered safer, the cost of capital for banks will actually decrease. More stable banks can issue bonds at a lower cost. At the same time, the stock market may assign higher P/E ratios to banks with lower capital structure risks.

The liquidity and leverage requirements of Basel III are designed to prevent unrestricted lending and borrowing, and to ensure that banks have sufficient liquidity in times of financial difficulties.

Basel III and investors

As with any regulation, the ultimate impact of Basel III will depend on how it will be implemented in the future. In addition, the trend of the international financial market depends on many factors, of which financial supervision is an important part. However, some possible impacts of Basel III on investors can be predicted.

The strengthening of banking supervision may be beneficial to bond market investors. This is because higher capital requirements will make bond investments issued by banks safer. At the same time, even if the economic growth rate slows slightly, the improved stability of the financial system will provide a safer background for bond investors. The impact on the currency market is not yet clear, but increased international financial stability will enable participants in these markets to focus on other factors, and less attention to the relative stability of each country’s banking system.

Basel III and the stock market

Finally, the impact of Basel III on the stock market is uncertain. If investors place enhanced financial stability over slightly higher credit-driven growth, stock prices may benefit from Basel III (other conditions being equal). In addition, greater macroeconomic stability will allow investors to pay more attention to the research of individual companies or industries without worrying about the economic background or the possibility of widespread financial collapse.

Basel III: Financial Results

Basel III is not considered a panacea. However, combined with other measures, these regulations have produced a more stable financial system. In turn, greater financial stability stimulated stable economic growth.

Although bank supervision may help reduce the possibility of future financial crises, it may also inhibit future economic growth. This is because bank loans and credit provision are the main drivers of economic activity in the modern economy. Therefore, any regulations aimed at restricting the provision of credit may hinder economic growth, at least to some extent. Nonetheless, many regulators, financial market participants, and ordinary individuals are willing to accept a slight slowdown in economic growth, provided that it means greater stability and less chance of a recurrence of events in 2008 and 2009.

Bottom line

Basel III should lead to a safer financial system while restraining future economic growth to a certain extent. For investors, the impact may be diverse, but it should bring a safer market for bond investors and greater stability for stock market investors. Understanding the provisions of Basel III will enable investors to understand the future of the financial industry, and at the same time help them to form a macroeconomic view on the stability of the international financial system and the global economy.

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