Basel III – good for stability, or a blow to Swedish banks?

Jan. 31, 2017

The Basel III negotiations are in their final phase – but what will the new regulations mean for Swedish banks? The Swedish House of Finance and SNS gathered a panel representing policy makers and banks to discuss consequences and risks with Basel III. Watch a video from the seminar (in Swedish), or read the summary in English.

At the Finanspanelen seminar, Kerstin af Jochnick, from the Riksbank (Sweden’s central bank), Uldis Cerps from Finansinspektionen (Swedens’ financial supervisory authority) and Hans Lindberg from Svenska Bankföreningen (Swedish Bankers’ Association) gave their view on what consequences the finalisation of Basel III will have on Swedish banks. The focus was on the so called output floor, the proposed change that would affect Swedish banks the most.

Kerstin af Jochnick started off by giving a background of the Basel committee, where the Riksbank is one of the parties representing Sweden. She stated that the negotiations of the finalisation of Basel III are soon to be finished. The committee and its regulations have roots that go back 40 years. In the first directive, Basel I, the size of the capital requirements was based on four classes of risk: loans to state, banks, housing and corporates. This was considered too inflexible, and in Basel II it was changed to capital requirements that are more based on risk, and where the level of risk can be calculated by the banks themselves.

However, this system, with internal models for risk calculation, has led to a dramatic drop in the capital requirements.

“The models are good for assessing risk, but the capital requirements that they deliver are too low”, stated Kerstin af Jochnick.

Several solutions to this are discussed in Basel III. The one change that would have the largest consequences for Swedish banks, is the introduction of output floors. An output floor would prevent risk weighted assets from reaching too low levels. The new floor would mean that no bank would be allowed to have their risk weighted assets below a certain quota of their value as calculated by the standard methods of the Basel Accord.

“We are discussing an output floor of between 60 and 90 percent. It is reasonable that you limit how much you can lower the risk weighted assets”, said Kerstin af Jochnick.

But even if the output floors are introduced, the full effect of the increase of capital requirements may not hit Swedish banks, stated Kerstin Jochnick. On top of the Basel II regulations, Sweden has national regulations that stipulate capital requirements that are higher than the minimum. When the global capital requirements are increased in Basel III, the national capital requirements should also be reconsidered, she said.

 

"Might give banks incentive to increase risk"
Uldis Cerps from Finansinspektionen stated that many of the measures suggested in Basel III are necessary, and some of these measures have already been taken by Swedish policy makers. But he was not convinced of all the regulations discussed by the Basel committee.

“The capital requirements would be increased for banks with low risk exposures on their books, which is a somewhat counterintuitive consequence. We claim that there are great differences in risk between different banks and different countries”, he said.

Uldis Cerps expressed a concern that the new capital requirements may be too standardized, and not sufficiently reflect the underlying risk. If the regulations do not reflect the underlying risk, it will give the banks incentives to increase their risk, without corresponding increase in the capital requirements.

“This would be an undesirable consequence”, said Uldis Cerps.

As for an output floor, Uldis Cerps said that Finansinspektionen would welcome such a regulation – given that the floor is calibrated on the low end of the range in order to retain appropriate risk sensitivity and avoid disincentivising banks from less riskier lending.

“The new agreement is necessary, but it has its shortcomings”, Uldis Cerps concluded.

 

"Could lower the GDP"
Hans Lindberg from the Swedish Banker’s Association was quite critical to the new regulations discussed by the Basel committee.

“it would mean a significant increase of the capital requirements for Swedish banks. Swedish banks are well managed, well capitalized and profitable compared to banks in other countries. The Swedish economy is a low risk economy, and that is reflected in the credit risk of the banks”, he said.

The level of capital required, according to studies conducted by the Swedish Banker’s Association, is about 12-14 per cent.

“More capital is not always better”, said Hans Lindberg.

An increase in the capital requirements would not only affect the banks, but the Swedish economy as a whole, warned Hans Lindberg. The country’s GDP would be lowered.

“The total cost of the global and national capital requirements, and the output floors, would be about 2,5 per cent of GDP”, stated Hans Lindberg.