Basel III: implementations and implications
To judge by a recent Basel Committee monitoring exercise, most leading banks have already made considerable progress towards complying with at least one of the statutory measures of Basel III. The results revealed that the weighted average Liquidity Coverage Ratio (LCR) of the Group 1 Banks was 114% and therefore already above the final requirement of 100% to be achieved by 2019. Of all the banks surveyed, 72% had already achieved this final level, while 91% had met the initial 60% requirement set for 2015.
So what are the practical implications of this for corporate treasuries? And are any such implications already priced into the market? Respectively, the answers currently appear to be: 'various' and 'only partially'.
Compliance with LCR, as well as the Net Stable Funding Ratio (NSFR) and Leverage Ratio requirements, means that banks have begun looking very carefully at their risk weighted assets and their allocation of capital. They will also be in varying stages of implementing strategic initiatives intended to align the optimal future use of their capital with Basel III compliance.
The extent to which this may already affect corporates obviously varies from bank to bank. An important factor is how a bank has typically funded itself. Some banks have been heavily dependent on external wholesale market funding. Therefore, the pricing and availability of their liquidity will be more heavily impacted by Basel III compliance than banks (such as HSBC) that have traditionally relied on the more conservative approach of funding through customer deposits.
Nevertheless, any changes already observed are unlikely to represent the final situation. Ultimately, Basel III is a set of guidelines that will be interpreted and enacted into law on a jurisdiction by jurisdiction basis – a process that is as yet incomplete. Furthermore, there are early signs of divergence among jurisdictions in their possible implementation of the measures. For example, a recent assessment report by the Basel Committee noted that some aspects of Australia's capital regulations, such as those relating to the definition and measurement of capital, were more rigorous than required under Basel III.
This sort of variance, coupled with the fact that the guidelines are not yet fully enshrined in law, means that final liquidity consequences of Basel III from a corporate perspective still remain unknown. Nevertheless, the prospective introduction of various Basel III liquidity ratios have certainly driven heightened awareness of bank balance sheet capacity across the market. So despite the relatively benign and stable interest rate environment in major markets, short and medium-term borrowing costs have already begun to increase to varying degrees.
Principles, interpretation and variability
While the LCR, NSFR and Leverage Ratio have attracted considerable public attention, there has been less focus on the Basel Committee's Principles for sound liquidity risk management and supervision, despite recent emphasis on these by the Committee Chairman, Stefan Ingves.
The principles reflect the spirit of the law, while measures such as the LCR and NSFR are its letter. Both are important, but the principles are by their nature more subject to interpretation. For instance, while the LCR sets a minimum quantitative threshold from a regulatory perspective, it does not necessarily reflect what an individual bank should do. Some banks may opt for an even more conservative LCR level than required because of the nature of their business, or their risk orientation, or some other factors.
Some of the analysis underway by banks includes:
- the evaluation of certain businesses, such as correspondent banking, in the light of the diminished funding value and prospective increase in leverage exposure caused by offering this service
- the evaluation of certain loan and deposit products, plus other solutions such as notional pooling
- a more complete balance sheet impact analysis of clients/industries based on both the liability dimension and not just the capital consumption of assets
The number of dimensions involved in this analysis means that there could be widely differing outcomes available to individual clients. This variability of outcome is also likely to persist, because bank pricing of assets and liabilities in the future will probably be more closely correlated with individual balance sheet configurations than, for example, an external market benchmark.
As banks will be looking more holistically at clients’ balance sheet impact, so should clients be more carefully analysing the value that they bring to a bank. There is the potential to unlock value by shifting away from the historical product purchasing orientation that may have been sufficient in the past.
The use of notional pooling may need to change as a result of the adoption of the Leverage Ratio. Historically, these structures have been predicated on the ability of both the bank and the corporate to achieve interest optimisation through the netting of single and multi-entity positions. Many treasuries used these structures as a safety net, in that they did not need to forecast and manage gross account positions actively, but instead could just manage to a net position across the pool. As banks become more sensitive to gross exposures in order to manage their Leverage Ratio, we can expect the introduction of more frequent settlement of pools, if not broader take up of cash concentration tools to manage self-funding.
Structuring global liquidity solutions in this new environment will be far more complex and will require much closer dialogue between the corporate treasury and the bank to determine the truly optimal solution. At the same time, this change in environment also reinforces the need to globalise liquidity structures and shift away from regional and currency-specific solutions that may not adequately reduce cash fragmentation.
The deposit landscape
The deposit market is another area likely to evolve as a result of Basel III. One example is the probable introduction of products such as evergreen notice or call accounts that create a residual maturity greater than 30 days. At the same time, the pricing of deposits that cannot be redeployed into lending will decline on a relative basis. This is effectively dictated by the leverage ratio: if a bank has a deposit that it cannot lend it must hold sufficient high quality liquid assets, which in turn affects its leverage ratio. Therefore, the bank has to decide whether the value of that deposit (including broader relationship considerations) is worth the implicit capital cost and opportunity cost of other assets that could have been held instead.
There is also likely to be a shift in the relative aggression of the bidding on certain types of deposit pricing. In the immediate aftermath of the financial crisis, certain institutions were bidding for short to medium-term liquidity. Since this liquidity may no longer be as contributory or attractive from a funding perspective, corporates’ excess cash will no longer attract a premium.
An interesting paradox in the Basel III deposit landscape is the operational deposit. An operational deposit is of value to a bank because it can be used to fund longer-term lending. On the face of it, this would suggest a valuable deposit of this nature would attract a higher rate. However, operational deposits under Basel III must be: "...held in specifically designated accounts and priced without giving an economic incentive to the customer to leave any excess funds on these accounts." Therefore, if a bank pays up for an operational deposit, it by definition ceases to qualify as operational.
Conclusion: differentiation and collaboration
Basel III presents a considerable opportunity for banks to differentiate themselves when it comes to the provision and compensation of liquidity. Key to this will be a bank's ability to understand the needs of clients and solve these needs on a composite, rather than product, basis. However, this is not a one way street. Corporates that not only engage with their banks over Basel III, but also attempt to understand the liquidity implications for each bank, will have a definite edge. They will be able to frame their funding and deposit objectives in the appropriate context for each bank so as to optimise possible rates and availability.
 Defined as internationally active banks with a Tier 1 capital of more than EUR3bn
 Keynote address to the seminar "Liquidity risk management - the LCR and beyond", Amsterdam, May 2014.
 Deposits placed by clients with banks in order to facilitate their access and ability to use payment and settlement systems and otherwise make payments.
 "Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools", BIS, January 2013.