Russian banks to adopt stricter reserve rules than West

In an announcement earlier today, the head of Russia's Central Bank, Elvira Nabiullina, stated that Russia's banks will be forced to comply with the new Basel III requirements starting on January 1, 2014. Basel III is the newest in a series of financial controls designed to strengthen the balance sheets of banks, in order to hopefully prevent any serious or systemic financial crises arising from a lack of an adequate reserve ratio. (For more detail on the Basel III rules themselves, see this downloadable report from KPMG from 2011, and for more recent news visit this section of the WSJ website).

While this many in America feel the new reserve requirements of Basel III are too stringent, and will harm not the U.S. economy, in particular the financial and housing sectors, in Russia the Basel III rules will actually be more severe than in the West. Ms. Nabiullina announced that the new Central Bank requirements for common equity will be 5 percent, capital assets at 5.5 percent (with an increase to 6 percent beginning January 1, 2015), and aggregate capital at 10 percent, according to an article from Russia Beyond the Headlines (RBTH). RBTH noted that "these requirements will be stricter than the Western ones, which provide for the adequacy of common equity at the level of 4.5 percent."

Basel III to be implemented in Russia - and then some. Image http://goldenageofgaia.com/wp-content/uploads/2013/06/basel-III.jpg

One analyst at VTB Bank, one of the largest banks in Russia, doesn't think that the Russian banking system will have much trouble meeting the tougher rules--mainly because the financial system in Russia is very different, in general, than in Europe or the United States,and credit rules are already tighter. Asset structure in Russian banks is still relatively basic and static, and there is a less favorable attitude towards highly leveraged bank balance sheets. Thus, the medicine of Basel III will be somewhat easier for Russian banks to swallow than their Western counterparts. In combination with the monetary policy of the Russian (and Ukrainian) central bank, and the general aversion to inflation, banks' more rigid credit policies are seen by some as limiting the potential growth of the Russian economy. At the moment, though, the priority throughout Europe, the US, and Russia seems to be stability rather than growth or profits.

However, it is important to note that the new effective date of January 1, 2014 for the Basel III rules is later than the original date, set in October of 2013. Svetlana Pavlova, assistant vice president and analyst at Moody’s, thinks that shifting the dates of Basel III’s implementation in Russia bodes ill for the country's financial sector. Also, the lowering of the capital assets level from the original 7.5% to the new 5.5%, while still strict, is seen by some as a matter of concern.

On the whole, the announcement about the Basel III “In general, capitalization is higher in our banks than in European ones. And this is correct: Considering the higher volatility of the Russian economy and tempo of growth of the banking sector, our banks need to be stronger to match the level of risk,” said Pavlova.

Basel III: rebuilding the capital of the global financial system. Image http://www.eamcap.com/wp-content/uploads/2010/09/Basel-III-capital.jpg

For more on this story, read the full article from RBTH here: http://rbth.ru/business/2013/07/22/banks_to_adopt_basel_iii_standards_in_2014_28277.html

International Banking: Regulation, A Capital Idea?

As soon as I saw the cover of last week's print edition of The Economist, I knew it was going to be an especially interesting read (moreso than usual). The special focus of the May 11th issue is on the current state of international banking--in particular the future of investment banking in the wake of the 2007-2008 collapse and the ongoing recovery.

While the "Leaders" piece on the resurgence of American investment banks vis-a-vis their European cousins/competitors is fascinating, as is this "Twilight of the Gods" piece on the leaner future of investment banking, it is the article on new banking regulations and their impact on the dynamics of international finance that has most intrigued me.

Entitled "Regulation: The bite is worse than the bark," the article starts by summarizing the atmosphere surrounding new and proposed banking regulations, using a quote from the current chairman of UBS, Axel Weber. In an interview, Mr. Weber stated, "The mood among investment banks that I talk to...is such that they expect that the regulation is over, they expect that they will be able to keep growing their balance-sheets, that they will be growing bigger than ever. The mood among the regulators I talk with is more like 'we haven’t even started.'"

While Swiss banks such as UBS and Credit Suisse have been hit particularly hard by newer, stricter regulations, Mr. Weber is uniquely qualified to comment upon the sentiment on both sides of the regulatory divide. And his comments are particularly troubling for international banks operating in America--not just the Swiss, but British and Germany firms as well.

But first, an overview of the three primary options available to regulators:
1) Higher capital and liquidity requirements;
2) Restrictions on bank activities such as trading for their own profit;
3) Structural changes such as forcing banks to “ring-fence” their retail banks from their trading businesses or to reorganise global businesses into national subsidiaries.

All banks are set to be subject to at least one of the three forms of corrective medicine, but the bigger and more complex banks likely face at least two if not all three forms of regulations in the near future.
I'll save the technicalities and complexities of Basel 3 and the Volcker Rule for a future blog post; but suffice it to say that while the new rules will likely create a more stable financial system, they are also having unintended consequences for international investment banks.

While none of the above regulations pose a deep, mortal threat to the future of America's biggest investment banking firms, The Economist reports that two further sets of rules being discussed "could dash the hopes of Europe’s remaining big investment-banking contenders, Barclays and Deutsche Bank, of being able to go on challenging the dominance of America’s biggest banks."

The first is "a proposal to separate investment banking from retail banking," which in Britain could mean the construction of a Chinese Wall of sorts between the retail-banking arm and the investment-banking division of a bank. Continental Europe, meanwhile, "is debating variations of a plan by Erkki Liikanen, the governor of Finland’s central bank, to separate banks’ trading operations." Both potential rules would mean an increase in funding and operation costs for Europe's banks, and would deter big global banks from operating in Britain or Europe.

America, meanwhile "has made it clear it wants to be in the game," and it has been American banks that have led the aggressive resurgence of Wall Street and fueled overall banking sector recovery. But in Washington, DC, a second set of regulations is on the drawing board that could deal a severe blow to the American operations of European-based global banks, by forcing big foreign firms to establish local holding companies for their American subsidiary operations. This would most obviously and immediately impact Deutsche Bank and Barclays, two of the leading European banks which have both avoided the new capital requirements by moving assets and deregistering their American holding companies.

As The Economist explains, the proposed regulations on foreign banks make perfect sense to American regulators: "if a big European bank collapses on their doorstep, they do not want to have to ask its home country for money." However, an executive at Morgan Stanley has estimated that Deutsche Bank has a hidden capital deficit of $20 billion in its American business that would be exposed by the new regulations. Barclays is in a similar situation.

Image taken from blog Special FX for Wizards

The bottom line? "If other regulators were to follow its [America's] lead and force all foreign banks to hold capital and liquidity locally, the era of financial globalisation would be over." And the end of global finance is something I don't think even the most gung-ho regulator truly wants. Personally, as someone interested in a career in international finance and who is considering working at a firm such as Barclays or DB after graduation, financial globalization is certainly something I hope continues for a long, long time.


You can read the article in full at this link: Regulation: The bite is worse than the bark. Feel free to leave your thoughts and comments below.