Irish banks could feel strongest effects of new Basel rules on capital

McKinsey report finds changed rules could see sector plugging a €120bn capital hole

The new standards from Basel will help to govern how banks make provision for bad loans. Image: iStock

The new standards from Basel will help to govern how banks make provision for bad loans. Image: iStock


Irish banks will be among those most affected by new regulations that could require the European sector as whole to plug a €120 billion capital hole, according to a new analysis from McKinsey.

The Basel Committee on Banking Supervision is putting the final touches to the Basel III post-crisis capital rules, setting stricter standards for how lenders estimate the riskiness of their assets. The global banking industry has dubbed this Basel IV, arguing that it constitutes a new, separate round of regulation. European resistance to aspects of the rules has stymied efforts to meet an end-2016 deadline to complete the process, which has now stalled.

“This is a game-changer for the European banking industry,” McKinsey said in the report. “Banks will need to raise more capital, and will likely have to take some unconventional measures to comply” with the new regulations, it said.

If all the rules come in as currently expected, McKinsey said, the greatest impact will be felt by banks in the Republic, Sweden, Denmark, Belgium and the Netherlands.

Particularly in the Nordic countries and the Netherlands, banks calculate their capital needs using traditionally low default rates on their mortgage portfolios. The new rules could limit the scope for that, driving up capital requirements, according to the report.

The report does not single out individual banks.

Shedding assets

Instead of raising new capital, banks could shed about €800 billion of risk-weighted assets to comply with requirements, McKinsey said. They could also review their businesses to identify areas that are “capital drags”.

The new standards from Basel, as well as a new accounting framework that will govern how banks provision for bad loans, will reduce European lenders’ common equity Tier 1 ratio, a key measure of financial strength, by 3.9 percentage points to 9.5 per cent in aggregate, the report said, based on figures as of mid-2016.

The main driver of higher capital requirements is a so-called output floor, a rule that acts as a blunt check on how much lower banks’ own estimates of asset risk can be, compared with those produced by standard formulas set by regulators.

The study also incorporates the effect of planned rules that cover how much capital banks use to fund the stocks, bonds, derivatives and other assets they have in their trading businesses.

“As the impact of new regulations varies between geographies and bank type or business model, institutions should make bank-specific impact assessments, identifying which portfolios and business segments are most affected,” McKinsey said.

“Banks need to develop a mitigation plan immediately for forward-looking market participants such as rating agencies and investors.”

– Bloomberg