The Implications of the Basel III Proposals

Standard & Poor's believes that Basel III will result in some banks having to make changes to their balance sheet structures or business models. "We expect smaller, deposit‐funded retail banks to find it easier to comply with Basel III's more stringent liquidity and capital requirements than larger wholesale‐funded institutions." They also believe that Basel III will likely cause more significant changes for wholesale‐funded institutions with their extensive trading operations or large loan books and securities holdings. “In particular, Basel III could have a major effect on the capital. "However, they are also likely to affect parts of the financial sector in ways that regulators may not have envisaged."

The International Institute of Finance (IIF) has some serious reservations about aspects of the package in the new framework that could undermine the overall objectives of the reform. The IIF calculated that the economies of the US and Europe would be 3% smaller after five years than if Basel III were not adopted. In this regard, Germany's Banking Association just reported that Germany's 10 largest banks may need 105 billion euros ($141B) in additional capital under the new Basel III provisions. Therefore, there is also a view that, if adopted as proposed, the Basel III proposals run the risk of creating unintended consequences for parts of the financial system. These unintended consequences could include constraining banks' lending activities and their ability to trade on derivative markets, hampering the inter‐bank lending market causing displacements in markets for high‐quality liquid securities, and encouraging banks to shift to short‐term lending.

The project then asks the following questions: Is Basel III a healthy development for the banking industry? Should banks hold more capital even if it means that banking activity, including lending, could be constrained? Do you think that this capital regime has the potential to limit credit crises in the future? Are the international regulators over‐reacting to the financial crisis and hampering the banks’ ability to lend and create liquidity to the market?