Introduction
Basel III necessitates banks to maintain specific leverage percentages and reserve capital levels to keep risk within international financial standards. The deadline for adopting the new standards has been continually shelved to its current date of 2023 (BIS, n.d.a). The United Kingdom delayed the adoption of the remaining Basel III financial requirements until March 2023. The UK postponed the introduction of Basel III standards in May 2020 owing to the effects of the COVID-19 outbreak.
Impact of the Changes
Minimum Required Capital
Banks’ necessity to uphold a minimum reserve capital of 7 percent will reduce their profitability. Even as they lessen the volume of loans provided to debtors, most banking institutions will attempt to retain a larger capital reserve to safeguard against monetary distress. They will be obliged to sustain a higher level of capital against their assets, reducing their account balance size (Jutasompakorn et al., 2021). Banks will be compelled to raise their lending margins and pass on the additional expense to their clients to remain solvent (Lileikienė et al., 2021). Basel III capital rules emphasize the reduction of counterparty threat, which differs according to whether a banking institution trades via a broker or a dominant clearing counterparty. If a financial institution participates in a derivative exchange with a trader, Basel III creates an obligation and necessitates a substantial capital charge.
The Leverage Proportion
The Basel III leverage ratio was implemented to prevent the banking system from being too leveraged and improve bank stability. Leverage ratios encourage banks to take on more risk because of the non-risk-based character of the proportion (BIS, n.d.b). According to this specific feature, leverage ratio requirements for EU banks should only lead to restricted additional risk-taking based on theoretical considerations and practical facts, resulting in more stable institutions. Many advantages can be gained by requiring a leverage ratio under Basel III. Heavily leveraged institutions have a lesser ability to absorb losses and are presumably less able to withstand a financial shock.
As was the case in the run-up to the financial crisis, this is of special relevance if the buildup of excessive leverage affects all of the banking industry. The Bank of England upped the minimum necessary ratio to 3.25 percent, from 3 percent, to prevent banks from decreasing their leverage capital levels beneath sensible levels in reaction to the financial crisis (Bank of England, 2019). A leverage ratio requirement guarantees that banks with a substantial percentage of low-risk-weighted assets have an additional loss-absorbing capacity by regulating the overall level of leverage they can reach. Because the risk-based capital framework does not completely cover unusual and strongly linked losses in the banking markets, the leverage ratio may be a superior metric for limiting aggregate risk and safeguarding against such incidences.
Liquidity Prerequisites
Adopting new liquidity regulations under Basel III guidelines will significantly influence the bond market’s functioning. To meet Liquidity Coverage Ratio liquid asset rules, banks will evade retaining high run-off properties, for instance, Special Purpose Vehicles (Schenk, 2021). Attributable to the Liquidity Coverage Ratio bias in favor of banks keeping government bonds and covered bonds, interest for secularized investments and lesser-quality funds will wane. To eliminate maturity misalignment and sustain a minimal Net Stable Funding Ratio, banks will keep more liquid assets and raise their percentage of long-term debt. Additionally, banks will limit investment activities that are more susceptible to liquidity problems (BIS, 2013). The introduction of Basel III affects the derivatives marketplaces as a greater number of clearing agents depart, attributable to increased costs.
Basel III Implementation in the UK
In 2021, the Prudential Regulation Authority (PRA) issued two policy statements addressing some globally accepted Basel III requirements that had not been adopted in the United Kingdom. Since then, the UK has developed Basel 3.1 recommendations to apply the remaining Basel III features (Buch & Goldberg, 2022). Basel 3.1 is the last set of practical banking regulations designed to retort to the economic crisis of 2008-2009 (Mdaghri & Oubdi, 2021). It is a comprehensive and substantial collection of metrics that will significantly alter how organizations compute Risk-Weighted Assets. The scheduling of the work on Basel 3.1 was indeterminate for several reasons, including the globally recognized interruption as part of the reaction to COVID-19 (Bank for International Settlements, 2017). Other rationales encompass the necessity to react to different preferences and the new systems that the PRA had to establish to transform Basel ethics into comprehensive rule-creating proposals within the UK legislative structure.
Basel III’s rapid and consistent implementation is essential for a banking sector that can sustainably support business development and recovery. In addition, the consistent use of Basel standards will enhance uniformity across engaged banking institutions worldwide (Cantú et al., 2021). The Group of Banking System Governors and Heads of Supervision, the Basel Committee’s supervisory body, approved the completion of Basel III changes in December 2017 (Asghar et al., 2022). After a one-year delay to strengthen the operational ability of banks and managers to react to COVID-19, these changes will go into effect on 1 January 2023 and be phased in over five years. The United Kingdom has accelerated the implementation of the newest global bank capital norms, increasing the likelihood that British banks would be required to comply earlier than their competitors.
The economic effect of the final segments of Basel III on British banks is unclear because the UK has provided no information on its approach to regions where national lawmakers have authority. For example, banks must set the level of capital for potential failures among corporate clients without a credit-rating agency score (Papadamou et al., 2021). The EU has stated that the measures will boost capital requirements for European banks by 9 percent by 2030 (Zweifel, 2021). The impact in the United Kingdom might vary significantly between large banks, such as Standard Chartered, and institutions with a domestic concentration, such as Nationwide, as the restrictions could result in increased capital requirements for some lending-related sectors.
According to UK Finance, which characterizes banking institutions in Britain, the Bank of England’s declaration on the initiation of new capital regulations provides much-needed clarification. By delaying Basel III’s implementation, not only will businesses design a more sophisticated and multifaceted project effectively, but they will also match their capital planning and strain testing for the next five years with the regulatory requirements. There will be a consultation document from the Bank of England describing how it intends to accomplish the remaining aspects of Basel III (Bank of England, 2021). The UK Parliament is now responsible for implementing global regulatory norms in domestic legislation instead of adopting new EU parameters, as the UK is no longer in the European Union. The PRA will be responsible for implementing the Basel Committee on Banking Supervision (BCBS) criteria once Parliament has approved it. The significant support for a more Basel-adherent approach to capital adequacy regulations among UK officials reinforces the PRA’s connection to the BCBS principles.
Conclusion
Basel III is a global regulatory agreement that mandates banks to maintain particular leverage ratios and reserve capital levels. Due to the COVID-19 outbreak, the UK postponed implementing Basel III standards. The requirement for 7% reserve capital will diminish bank profitability. The impact in the UK may differ between major banks like Standard Chartered as the limits may result in higher capital requirements for various lending-related businesses.
References
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