Is Basel 3 doomed to deal further harm to the UK economy?

What are the potential implications for financial services in the UK if the regulators enforce the Basel 3 standards to the fullest extent? Ross Henry Law, senior reporter at FStech, reports.

Reports recently emerged that the Bank of England (BoE) was considering a ‘dilution’ of its approach to the implementation of the Basel 3 standards.

Basel 3 is the latest iteration of the Basel rules – a set of guidelines which were introduced in the wake of 2008’s Global Financial Crisis as a means of safeguarding against future emergency by dictating bank capital requirements. The latest version, Basel 3, is set to come into force in 2025.

Reports around a potential softening of the BoE Prudential Regulatory Authority’s (PRA) stance around Basel 3 follow dismay from some of the UK’s largest banks which argued that implementing the standards in the ‘strictest’ sense would harm the UK economy and small businesses in need of capital.

NatWest and HSBC estimated that they would have to hold billions more back on their balance sheets than their EU counterparts – an extra £34 billion and £18 billion respectively – to meet the rules if they were to be adopted in the strictest sense, as the PRA has initially proposed.

Acknowledging the strictness of Basel 3 and that it may significantly increase the capital banks must put aside in different asset classes, Osmond Plummer, senior lecturer at the London Institute of Banking and Finance, says Basel 3 in any form will likely mean that banks are less willing to lend.

"Whatever happens, Basel 3 implementation is going to be restrictive on lending and that's never brilliant for an economy," he says.

“A strict interpretation of the rules could make it more difficult for banks to lend and in turn more difficult for businesses to borrow,” he adds. “That in itself isn't the end of the world, but what happens is you push those borrowers into the shadow banking market which is not healthy due to the lack of regulation.”

Remaining competitive in a post-Brexit Britain

Plummer believes that the UK regulators are worried about being uncompetitive and will try to find a “healthy middle-ground” around Basel 3.

With a view to Brexit and the UK having left the single market, Plummer points out that London is losing listings and business to other financial centres such as Paris and Frankfurt.
“With the City of London losing clout as it is,” he says, “I think the regulator, probably rightly, needs to do something to at least meet European standards a little more evenly or it's over to a certain extent.”

He continues: "Interest rates are at higher levels than they've been for some time and so banks are making a lot more on their interest rate margins than they have done for years, yet they are still going to be more cautious, and the cost of lending is not going to decrease if you've got a higher capital requirement; and this is an added headache for certain businesses that are dependent on being able to borrow if the cost goes up as precipitously as it has been."

Support for SMEs

UK banks have reportedly also been lobbying against the PRA’s initial proposals which could see it remove a Basel rule dubbed the "SME support factor", a measure which enables banks to ease the burden on capital requirements for credit risk on exposure for SMEs.
While Plummer views the prospect of weakening the Basel 3 rules before they have been implemented as somewhat counterintuitive, he contends that SMEs should be an important focus for the regulators.

“The SME side of things is where in the UK we need to be able to get attention to grow the economy, to get some of these SMEs ‘on fire’, to hopefully no longer be SMEs,” he says.
Plummer notes, however, that taking away or leaving such a rule in the Basel 3 standards amounts to a “damned if you (the PRA) do, damned if you don’t” situation.

“The regulator will be judged according to the results,” he says, noting that the PRA can’t really win in this sense.

"If the standards are lessened and there's a bit of a meltdown, the standards shouldn’t have been lessened; and if the standards aren’t lessened and there’s no meltdown, the standards should have been lessened,” he explains.

Balance in the evolving economic environment

Generally speaking, Plummer believes that implementation of the rules should be a balancing act between regulatory responsibility and enabling growth.

“The PRA will have to make their case very clearly on what they decide,” he says. “I would suggest it's not going to be a once and for all system and should be reviewed on a relatively regular basis to see if anything needs tweaking with the current economic circumstances in mind.”

Acknowledging that such an arrangement won’t necessarily be helpful for banks that want one rule that's going to stand, Plummer hopes the rules and regulatory requirements are implemented with a degree of dynamism that will “allow for prudent regulation within the context of the developing economy.”

While we are still some way out from Basel 3’s 2025 enforcement date, murmurings suggest that the PRA and BoE are taking heed of the banking sector’s grievances around the current implementation proposals and appear to be gauging sentiment in the finance sector and eyeing a middle-ground which will benefit UK lenders while safeguarding against another GFC.

An executive in the financial services industry recently told the Telegraph that the PRA’s engagement with the finance sector had been constructive.

The source said: “I think Sam [Woods, chief executive of the PRA] is listening.”

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