Moody’s: Basel 3 insufficient to strengthen bank’s credit

In their latest press release on May 4, Moody’s rating service confirms what many had the common sense to understand on their own. It is impossible to legislate oneself out of a crisis, and credibility and accompanying credit comes as a product of fullfilling obligations and successes, not international finance laws.

New York, May 04, 2011 — Moody’s Investors Service says in a new report that although Basel 3 is credit positive for banks, the standalone financial strength of banks weakened by the global financial crisis is unlikely to return to pre-crisis levels in the short term. The report discusses the likely impact of Basel 3 on bank credit profiles and how different groups of banks may be affected in the new Basel 3, post-crisis environment.

The framework agreed by the Basel Committee on Banking Supervision in the aftermath of the financial crisis sets new standards for global bank regulation. “Basel 3 will be positive for bank creditors overall, as it will improve the resilience of the global banking system by adding sizeable capital and liquidity buffers,” says Vice President and co-author of the report Tobias Moerschen. The recovery of banks’ credit profiles, however, is constrained by the pressures many institutions still face given the fragile economic recovery in developed markets, skittish financial markets, and new global risks.

“While directionally positive, Basel 3 does not cure the structural challenges banks continue to face from a credit perspective, such as illiquidity and high leverage, nor does it alleviate the tension between profit-maximizing equity holders and bank managers in contrast to risk-averse bondholders,” notes Senior Vice President and co-author of the report Alain Laurin. While important, the new regulatory framework is therefore only one part of the broader effort to improve banks’ resilience to economic downturns.

Stricter regulatory standards and investors’ elevated focus on risks in the post-crisis environment will not affect banks in a uniform manner. The report discusses three different groups of banks: 1) institutions that are able to raise additional capital and bolster liquidity to meet Basel 3 requirements, which may see their credit strength improve; 2) weaker banks that will be challenged to comply with the new rules, and may see their credit profiles deteriorate; and 3) banks that are already largely compliant with Basel 3, whose credit strength likely will remain stable. With the new rules acting as a catalyst for change, weaker banks may seek acquirers, seek government support, or wind down part or all of their operations, with potentially adverse consequences for creditors.

The report notes that considerable uncertainty remains about the effects of Basel 3 due to the long transition period (banks have until 2019 to fully comply) and the likelihood that parts of the proposed framework may change. Additionally, jurisdictions may differ in how they adopt the new rules, with the potential for regulatory arbitrage. Banks are also just beginning to formulate how they will adapt to the Basel 3, post-crisis world and their strategies could have a significant impact on their intrinsic financial strength.

Sadly, for the body of politicians who participated in the Basel process, increasing buffers and reserve requirements when the economy is on the fringe and no financial institution has the funds available to contribute to said buffers (which was sort of the problem to begin with), can hardly be helpful to the immediate release of the system.

And even worse for them, enacting a banking reform after a banking crisis is hardly great enough of an endevour to immediately reduce all pessimism in the system.

Perhaps Basel 3 will be helpful down the road, but for now, it isn’t.