No more cheap money? Banks forced to boost cash reserves

The new Basel III requirements (for banks to hold capital buffers of 7%) might boost borrowing costs, as well as stability.

by James Taylor
Last Updated: 19 Aug 2013
We appreciate that it's hard to get too excited about a meeting in Switzerland between a load of central bankers and regulators (as weekend plans go, it's not exactly up there). But their conclusions - to be known to posterity as Basel III - will have far-reaching implications. Under the new rules, the big banks will see their core capital requirement almost triple to 7%, so they'll be better equipped to withstand future economic shocks. And while it's good for all of us if our banking system is less vulnerable to overnight collapse, the flipside is that the banks will see their cost of doing business increase - so loans are likely to become more expensive and harder to come by...

After a weekend of behind-the-scenes wrangling, the assembled technocrats finally agreed a new set of rules, designed to make the banking system more stable. The most significant of these is that individual banks will have to hold more capital relative to their assets - so they'll need a core tier-one capital ratio of 4.5%, more than double the current level of 2%, plus a 'counter-cyclical' capital conservation buffer of 2.5% (taking the effective total to 7%). If they don't play ball, they won't be able to pay dividends. There was also a vague suggestion that banks considered 'too big to fail' will be subject to even more stringent requirements - although typically, they don't seem to have decided what this will actually mean in practice.

The theory is that if the banks have more cash in the, erm, bank, they'll be less vulnerable if/ when everything goes pear-shaped again. In retrospect, it's not that surprising that it was a bit risky allowing them to clock up dodgy assets worth fifty times as much as their actual capital; now, they should be better placed to cope if a load of their debts suddenly go sour. That's good for us taxpayers, because we won't have to shell out billions to bail them out again.

However, as with all these things, there's a downside. If banks have to hold more of their capital as a buffer, they'll have to less money to dole out to us - and the money they lend will be more expensive. So the risk is that the new rules will suck money out of the economy at the worst possible time.

Still, the good news (not least for the banks, who have seen their share prices rise accordingly) is that they've been given the best part of a decade to comply - the new rules won't kick in fully until 2019. And most of our big banks are already well above this 7% level (indeed, the UK was pushing for double figures across the board). So, as rules foisted on the UK by unelected technocrats behind closed doors in Europe go, this could turn out to be one of the more palatable.

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