Fitch report shows Basel 3 capital requirements will reduce banks’ return on equity by 20 percent.
Big banks stashing buffer bucks to satisfy Basel 3 rules will see their return on equity diminished. That’s the conclusion of a Fitch report that said 29 of the world’s largest banks – global systemically important financial institutions or G-SIFIs – might need to raise about $566 billion in common equity in order to meet Basel 3 capital requirements. This would translate into about 20 percent cut on their returns.
This once again shows the uncertainty that treasurers likely see as they scan the funding landscape. But it’s not all bleak, Fitch said. The report suggested that the higher capital requirements could be offset simply by the competitive advantage of being considered G-SIFI. “Some investors and counterparties might perceive these institutions as more likely to receive government support in a distress scenario. This perception, coupled with the G-SIFI’s higher capital standards, could in turn reduce funding costs and stimulate business flow from more risk-averse customers,” Fitch wrote.
But on the other hand, Fitch warned, “institutions that deem G-SIFI status as a regulatory burden might seek to reduce or limit their size and complexity in order to avoid this designation.”
Exacerbating the capital issue is that banks are being pressured to meet the Basel 3 requirements early, even though officially they’re not required to be compliant until 2018 (see related story here). This capital increase “would imply an estimated reduction of more than 20 percent in these banks’ median return on equity from about 11 percent over the past several years to approximately 8 percent to 9 percent under the new Basel 3 rules. “Basel 3 thus creates a tradeoff for financial institutions between declining ROE, which might reduce their ability to attract capital, versus stronger capitalization and lower risk premiums, which benefits investors,” Fitch said.
All this might not mean a lot to investment-grade US and European MNCs, most of whom are already well-diversified in their funding. Nonetheless, they should make sure they are pursuing facilities that will stay undrawn, with documentation language to match, since pricing and availability for funded facilities will be dramatically different as (early) Basel 3 compliance draws near.
For banks and their corporate clients in Europe it’s a different story, as some 60 percent to 70 percent of companies rely on bank credit as opposed to capital market funding. This might mean that treasurers of companies there may see some of the most mission-critical bank offerings curbed or done away with altogether. If a company needs bank credit lines to run its business, it’s in trouble. Treasurers will then need to figure out how to fund via capital markets quickly.