23 January 2014

Basel’s big balancing act

This news was first published on Dialogue Online.

There is an untold Basel III story, and it’s about balance. You won’t find it in the texts, nor indeed in any executive summary. But the Basel Committee’s recent modifications of the Basel III leverage ratio don’t just ease trade; they just might be indicative of a (new?) spirit of co-operation between regulators and the banking industry.

The modifications are, in effect, a cost-cutting measure implemented by regulators for the benefit of banks. They include provision for netting of exposures to a given counterparty, and for the exclusion of some trade exposures to qualifying central counterparties when the ratio is calculated (the leverage ratio is, briefly, capital/exposure expressed as a percentage). “This is good news for developing countries,” World Trade Organisation director general Roberto Azevêdo. It might also be good news for the banks.

A little more conversation

“The latest updates to the Basel framework represent an appropriate refinement to the treatment of trade finance, that has been welcomed by the Banking Commission of the International Chambers of Commerce, given the risk profile of that asset class,” says Alexander Malaket, president, OPUS Advisor, a consultancy specialising in trade finance. The key word here is “appropriate”. Looking beyond trade finance, Malaket continues:“The broad regulatory pressures faced by the banks have created significant need for regulatory resources and regulatory infrastructure. The question is, how do you strike the balance between appropriate regulation and the ability to handle legitimate business?” At least part of the answer is, you price risk appropriately, rather than over-emphasise safety, and you consult.

“From a trade finance perspective, a major lesson learned is the importance of effective communication, collaboration and advocacy,” says Malaket. This is a not-quite-new but increasingly critical issue facing banks across their whole range of service provision. Richard Barfield, director of risk consulting, UK banking, PwC, says, “We need enlightened and informed politicians, governments, central banks and treasury departments, who are in a position to make the call in terms of the trade-off between safety and economic growth. We’re probably going to see that discussion come more sharply into focus over the next year or so.” There are signs of improved economic growth, notably in the EU, and banking services are the obvious key to enabling that growth to take hold.

Enlightened self-interest

As both Malaket and Barfield suggest, effective regulation is a collaborative process. But if what’s needed is a dialogue between stakeholders, that dialogue has to be grounded in enlightened self-interest. In terms of banking-service provision, without any flexibility, Basel III is just another cost factor. Barfield says: “The fundamental thing that will happen is that there will be a repricing of bank products, both services and lending. This will take some time to work its way through, but it seems to me that it’s inevitable.” Higher costs gave an inevitable impact – on SME lending, for example – and can prompt banks to re-evaluate their service provision overall.

So what’s happening today? At the micro level, there have been some interestingly nuanced repositionings of late. To cite one recent case, Wells Fargo withdrew its Direct Deposit Advance loan service in January 2014, after increasing its investment in Grameen America’s micro-loan service in November 2013. “We are only as strong as the communities we serve,” says Sarah Bennett, senior vice president, Wells Fargo, commenting on her bank’s increased commitment to “very small enterprise” lending.

At the macro level, the costs/benefits of regulatory compliance would be problematic to assess even without Basel III, not least because some potential business areas can seem to be almost regulator-led. Banks might face a choice between, for example, developing their European cross-border payments business in compliance with the SEPA roadmap and rulebook – or getting out of that line of business altogether. With Basel III - and not forgetting the full range of other regulatory obligations placed on banks today - the risk (sic) is that regulation might begin to have consequences almost diametrically opposite to those intended.

Mind the gap

Trade goes on, even if trade finance can’t be sourced traditionally, just as there is financial activity among the unbanked. In March 2013, the Asian Development Bank published a finding that there is a US$1.6 trillion trade ‘gap’, representing the value of trade in search of finance globally. Elsewhere in banking, another possible straw in the wind is Oaknorth. It’s a start-up bank, one of a number currently going through the UK’s bank-licensing process, and its business model will “seek to augment traditional banking practices with digital/new form lending techniques”. Oaknorth’s team includes Chris Dailey, ex-GE Capital, and Richard Davies, formerly a senior corporate banking executive at Barclays.

It’s just possible that the most attractive feature of Basel III is its apparent capacity to adapt – as indicated by its recent modification. “The rationale to put more capital into the banking industry is generally accepted,” says Barfield. Yes. Banks need to be capitalised appropriately. But they also need to be responsive to the legitimate demands of “safe” and “risky” markets and business sectors alike, and regulators have a part to play in making that possible.