Basel reveals liquidity gap for biggest banks

By Brooke Masters and Patrick Jenkins in London

Published: December 16 2010 19:18 | Last updated: December 16 2010 19:58

The world’s biggest banks have a combined €1,730bn ($2,287bn) gap in liquid investments that they must fill within four years, according to the Basel Committee on Banking Supervision, the international banking watchdog.

Under the Basel III rule book, finalised by the committee on Thursday, 91 of the world’s biggest banks – tested in an impact assessment – also have a €577bn capital shortfall compared with the new 7 per cent headline number for equity tier one capital, a measure of financial strength.

The Basel III rules, which are to be phased in in the next few years, demand that 30-day liquidity be beefed up by 2015 and that the capital ratios are met by 2019. The market has been braced for months for the capital shortfalls, which analysts believe will be largely coverable with retained profits. But the liquidity gap, particularly sensitive given the currently malfunctioning interbank markets in the eurozone, is a shock.

“There is a considerable concern about finding an effective way of bridging such a shortfall bar drastic changes to business plans and business disposal programmes which may be unfeasible or imprudent within the transition period,” said Etay Katz, regulatory partner at Allen & Overy.

The reforms aim to make banks more resilient to financial shocks following the collapse of several banks and the rescue of others by governments around the world. Nout Wellink, Basel committee chair, hailed the publication of the detailed rules as “a landmark achievement that will help protect financial stability and promote sustainable economic growth”.

Bank protection

Banks should stop paying large cash bonuses or dividends in order to boost their resilience against the danger of a wider and deeper eurozone crisis, the Bank of England demands on Friday in its latest Financial Stability Report, report Chris Giles and Jennifer Hughes in London.

Officials fear that although progress has been made in improving banks’ ability to absorb losses, the interconnectedness of the European banking system risks amplifying any losses stemming from peripheral economies such as Greece, Ireland and Portugal.

“UK banks have claims of almost £300bn on France and Germany, whose banking systems are more heavily exposed to the most affected economies,” the Bank warns. It adds that although UK banks have limited direct exposure to peripheral European sovereign and bank debt, renewed stresses would also create large losses in banks’ portfolios of loans in the eurozone.

The Basel committee said the top 91 banks would have a combined core tier one capital ratio of 5.7 per cent, under the rules agreed this year, compared with 11.1 per cent under current rules.

The number is much lower because the definition of the ratio is being tightened, disqualifying non-equity capital from the numerator and ramping up the risk weightings of assets in the denominator.

Although the forecast ratio is comfortably above the new absolute minimum ratio of 4.5 per cent, the rules say that any bank with less than a 7 per cent ratio will face significant restrictions on bonus and dividend pay-outs, making that the de facto minimum for most.

The results of the assessment explain why the committee has agreed to phase in the requirements over the next eight years.

The Basel committee numbers are based on December 2009 data so some banks have already made changes to bring them into compliance. However, analysts pointed out that the impact assessment did not include the potentially severe effect of the currently undecided supplementary capital that so-called systemically important financial institutions will have to hold.

In some areas there have been tweaks to soften the impact. Analysts at Credit Suisse said the new treatment of risk weightings was “definitely less draconian”, making the capital gap less severe than it would otherwise have been.

The Basel committee also made some adjustments to the way one of its liquidity rules will be calculated.

The change to the “net stable funding ratio” is intended to address complaints that the rules favoured investment banks over those with large retail operations.

“Banks should now have enough information to plan for implementation and the transition,” said Stefan Walter, secretary-general of the committee.