One of the biggest tenets of the plan is to have banks hold their common-equity capital at 7% of their risk based assets, compared to the currently upheld standard of 2%. The only problem is that for banks that don’t have this capital on hand, they have to come up with money to fill the 5% gap.
The impact that Basel III could have on banks ranges from less lending capability, to less risk taking. Since banks will have to raise capital, one way to do this would be to lend less in the short-term. An unsavory scenario would be that Basel III could cause a short-term drought for investors and entrepreneurs looking to raise funds for projects. This of course has the potential to halt economic growth at a time when we need anything but. However, banks don’t have to write checks for millions of dollars—there’s no specific amount of capital that has to be raised or forked over. Rather, they have to play with balance sheets to shift percentages of risk.
At the same time, Basel III’s most intrinsic qualities are intended to protect the market from the exact type of pitfalls that plagued the late 2000’s crisis. Most notably, a higher risk weight attached to real estate loans is going to prevent banks from being bucked as easily by tumultuous real estate and development markets. The 2008 crisis reached its ultimate nadir because banks had no backing when the market slid out from under them. The 7% equity-capital rule will give banks a potential short-term headache, but will protect themselves and customers in the long term as they will be better insulated from market fluctuation. Having enough capital at their peak will prevent banks from requiring bailing out or causing market failure at their lowest points.
As Basel III factors into banks plans, an international waiting game is being played to see how various people will comply. There’s no doubt in bankers minds that some won’t comply, that some could get punished for playing by the new rules, and that some could be rewarded by remaining status-quo. The tangible reach of the new accord remains to be seen as a firm regulatory act.
Basel III’s legacy in history books will be included as a footnote, or possibly an entire chapter depending on its reach. Some banks realize that Basel III is going to make longer term investments more expensive. Others feel that requiring banks to keep less loans on their balance sheets to meet the 7% requirement will lead to less startup capital available for businesses and investments, leading to slower economic recovery. If Basel III does not work to fix the ills of the late 2000’s economic crisis, another regulatory decree will be required that raises capital, but perhaps not to such an exorbitant degree. Basel III might save banks form themselves in the short term, but it remains to be seen what it’ll do to a sagging economy in the long term.