The fundamental issue of the credit markets today involves availability. That single issue affects you, me, the respective companies we work for, and everyone we know. If financial institutions are willing to lend, and lend freely, and we benefit. If not, capital becomes more expensive, and the growth slowdown occurs.
True? Not entirely. We’ve seen the results of extreme overabundance of available credit which ended in late 2006, 2007. And we’ve seen the opposite extreme of limited available credit, opaque lending rules, and other emergency constraints imposed on the lending industry.
The most common use of credit in the United States is, by far, credit cards In terms of the number of transactions. According to the Nilson report, the number of credit card transactions in the United States per year is close to 25 billion. That’s more transactions than every other type of consumer lending combined and multiplied by 1000.
The biggest news story this week is also the hardest to understand: the new banking rules established by top bankers and regulators in Basel, known as the Basel III Accords. The question is, how will the Basel III accord affect lending worldwide, and by extension will that trickle down to your individual credit card? Let’s see.
WHAT IS BASEL III?
Under the terms of the Basel III framework, banks’ minimum total capital, the definition of which has been in play throughout this process, rises sharply, from 2 percent to 7 percent of risk-adjusted assets. There are barriers in place to ensure that institutions have the ability to absorb losses during future economic periods of downturn. For example, an additional counter-cyclical buffer will range from 0% to 2.5% depending on specific geographic location of the financial institution, specific circumstances, and other factors.
Why 2.5 and not 3 percent? The reason is simple: this is a political issue as much as any science of risk management. Exact numbers aside, the Basel Committee believes that the changes support its goal of reducing the pro-cyclicality of credit by improving the quality and quantity of banks’ capital cushions. Still, few changes will be immediate. A phase-in period begins in 2013. The common equity requirements come into force in 2015; the additional buffer, in 2019.
BAD FIT WITH DODD-FRANK?
New worldwide financial regulation has been a hot political topic since July of this year, which is when the U.S. passed the massive Dodd-Frank regulation bill. Then, in September of this year, the Basel Committee announced its new capital standards that global banks must follow with its Basel III accord. But a new report from Yalman Onaran at Bloomberg suggests that these two efforts might not fit together particularly well. A provision in Dodd-Frank strips rating agencies influence from regulations, and that could make it more difficult to implement the new capital rules.
Here’s an excerpt from the Bloomberg article explaining the problem that this creates:
The financial-overhaul legislation, signed by President Barack Obama in July, requires regulators to remove all references to credit ratings of securities from their rules. Revised standards on how much capital banks need to hold against such assets in their trading books, approved by the Basel Committee on Banking Supervision in 2009, rely on such ratings.
That means the U.S. will have to develop another mechanism that doesn’t depend on firms such as Moody’s Investors Service and Standard & Poor’s, a process that threatens to slow adoption of the Basel rules on market risk as well as a separate package of regulations on bank capital and liquidity agreed to this month, known as Basel III, bankers and lawyers say. The delay also gives ammunition to European regulators and politicians who have criticized the U.S. for dragging its feet on compliance with previous standards while pushing for their approval.
It’s a little difficult to see why this would be such a huge problem, however, considering the legislation and the Basel III timeline.
HOW WILL IT IMPACT YOU?
In a preliminary assessment of Basel III’s implications for the credit market, including credit cards of all types and commercial real estate, the new risk calculations could exert a drag on a higher level of securitization of the market. It is unclear if the higher costs are in line with any quantifiable assessment of risk. Separately, there is an open question about whether small borrowers will be disproportionately impacted by higher loan costs. But there are ample tools that domestic regulators have at their disposal—should they wish to use them—to offset any observable and negative impact on small businesses and small commercial real estate borrowers.
The impact of Basel III rules on the real economy is subject to “considerable uncertainty” but should not undermine the economic recovery, European Central Bank Governing Council member Axel Weber said on Wednesday.
“I am not afraid that the implementation of Basel III might significantly impair the lending capacity of banks or hamper economic recovery,” Weber said in the text of remarks for delivery at the Eurofi conference here.
“While being subject to considerable uncertainty, recent comprehensive impact studies by the Basel Committee and the Financial Stability Board suggest the economic impact during the transition period will be moderate and that the long-term net benefits will be positive,” Weber noted.
For the time being, Basel III offers debt-hungry lenders and financial institutions in the United States no cause for alarm. Nor do domestic banks have much to fear. As part of its balancing act, the new accord has little that might undercut the basic incentives to lend or to borrow, or that will require American banks to undertake new capital-raising – and ‘now’ is not the time for that.
© 2010 David Schropfer
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