Basel III Summary, And The Fed's Endorsement of 20x+ Leverage

Tyler Durden's picture

Earlier today, the Basel Committee on Banking Supervision committee released Basel III guidelines, which are expected to have a material impact on curbing bank risk appetite... when they are fully implemented in July of 2019. Luckily by then the last thing on people's minds will be whose bank's Tier 1 capital (which includes such intangible "capital" items as mortgage servicing rights and preferred stock) was being misrepresented for the past 9 years, as real cap ratios are discovered to have had a decimal comma following the zero. In the meantime, here is the summary of the proposed changes to bank capitalization requirements, which apparently were so "stringent" that the Fed issued a Sunday afternoon press release patting itself, and the entire financial system on the back, for pulling off another multi-trillion toxic debt David Copperfield disappearing act. So for the next several years, banks will need to demonstrate a stringent 4.5% Common Equity cap ratio, in other, will be allowed leverage over 20x. And this is the "stringent requirement" that has forced Deutsche Bank to sell over $12 billion in new stock to raise capital. Furthermore, the coincident take over of Post Bank will surely allow DB to terminally confuse
its investors as to what its final pro forma numbers are supposed to
represent, and, more importantly, what the unadjusted actuals really
are... Surely this example of just how woefully undercapitalized European banks are (consider the DB action a stark refutation of the "all is clear" statement proffered by the Stress Test farce from July) will be enough to get the EURUSD back to 1.30 overnight.

Basel III Sumary terms (courtesy of BiiiCPA)

A. Tier 1 Capital

A1. BASEL II:

Tier 1 capital ratio = 4%
Core Tier 1 capital ratio = 2%

The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 capital.

A2. BASEL III:
Tier 1 Capital Ratio = 6%

Core Tier 1 Capital Ratio (Common Equity after deductions) = 4.5%

Core Tier 1 Capital Ratio (Common Equity after deductions) before 2013 = 2%, 1st January 2013 = 3.5%, 1st January 2014 = 4%, 1st January 2015 = 4.5%

The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 capital.

B. Capital Conservation Buffer

B1. BASEL II:
There is no capital conservation buffer.

B2. BASEL III:
Banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%.

Capital Conservation Buffer of 2.5 percent, on top of Tier 1 capital, will be met with common equity, after the application of deductions.

Capital Conservation Buffer before 2016 = 0%, 1st January 2016 = 0.625%, 1st January 2017 = 1.25%, 1st January 2018 = 1.875%, 1st January 2019 = 2.5%

The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions.

C. Countercyclical Capital Buffer

C1. BASEL II:
There is no Countercyclical Capital Buffer

C2. BASEL III:
A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss absorbing capital will be implemented according to national circumstances.

Banks that have a capital ratio that is less than 2.5%, will face restrictions on payouts of dividends, share buybacks and bonuses.
The buffer will be phased in from January 2016 and will be fully effective in January 2019.

Countercyclical Capital Buffer before 2016 = 0%, 1st January 2016 = 0.625%, 1st January 2017 = 1.25%, 1st January 2018 = 1.875%, 1st January 2019 = 2.5%
 

D. Capital for Systemically Important Banks only

D1. BASEL II:
There is no Capital for Systemically Important Banks

D2. BASEL III:
Systemically important banks should have loss absorbing capacity beyond the standards announced today and work continues on this issue in the Financial Stability Board and relevant Basel Committee work streams.

The Basel Committee and the FSB are developing a well integrated approach to systemically important financial institutions which could include combinations of capital surcharges, contingent capital and bail-in debt.
 
Total Regulatory Capital Ratio = [Tier 1 Capital Ratio] + [Capital Conservation Buffer] + [Countercyclical Capital Buffer] + [Capital for Systemically Important Banks]

And here is what the Fed released on a busy Sunday afternoon.

U.S. Banking Agencies Express Support for Basel Agreement

The U.S. federal banking agencies support the agreement reached at
the September 12, 2010, meeting of the G-10 Governors and Heads of
Supervision (GHOS).1 
This action, in combination with the agreement reached at the July 26,
2010, meeting of GHOS, sets the stage for key regulatory changes to
strengthen the capital and liquidity of internationally active banking
organizations in the United States and around the world.

The U.S.
federal banking agencies actively supported the efforts of the GHOS and
the Basel Committee on Banking Supervision (Basel Committee) to
increase the quality, quantity, and international consistency of
capital, to strengthen liquidity standards, to discourage excessive
leverage and risk taking, and to reduce procyclicality in regulatory
requirements.  The agreement represents a significant step forward in
reducing the incidence and severity of future financial crises,
providing for a more stable banking system that is less prone to
excessive risk-taking, and better able to absorb losses while continuing
to perform its essential function of providing credit to creditworthy
households and businesses.

Today's agreement represents a significant strengthening in prudential standards for large and internationally active banks. [TD: in other news, the subprime crisis is contained]

The
GHOS agreement calls for national jurisdictions to implement the new
requirements beginning January 1, 2013.  The GHOS announced that the new
numerical minimum requirements would be phased in over two years
beginning on January 1, 2013, and that certain capital deductions and
the phase-in of capital buffers would occur over time from January 1,
2014, to no later than January 1, 2019.  This transition period is
designed to give institutions the opportunity to implement the new
prudential standards gradually over time, thus alleviating the potential
for associated short-term pressures on the cost and availability of
credit to households and businesses.  Consistent with this objective,
supervisors will be evaluating an institution's capital adequacy on the
basis of the then-applicable standards as well as the strength of an
institution's plans to meet future standards as they come into effect.

The
U.S. federal banking agencies support and endorse the efforts of the
GHOS and the Basel Committee to strengthen the capital position of large
and internationally active banks.  The Dodd-Frank Wall Street Reform
and Consumer Protection Act requires the establishment of more stringent
prudential standards, including higher capital and liquidity
requirements for large, interconnected financial institutions. 
Moreover, the Basel Committee continues work on the development of
measures to improve the loss absorbing capacity for systemically
important financial institutions.  This work would augment the standards
announced by the GHOS today.