While bankers and financial markets anxiously await details that could come as early as this weekend on how high international regulators plan to raise capital standards, it remains unclear if the industry will get all the answers it wants.
Negotiators for the Basel Committee on Banking Supervision met Tuesday to work out further details of a proposed capital framework ahead of Sunday's meeting in Switzerland with the group of governors and heads of supervision.
It appears officials are close to signing off on a broad agreement, but sources close to the situation said some key details remain in flux, raising concerns of how markets will react if critical elements are not disclosed by Monday.
"Anytime you have lack of clarity on what the standard is going to be, it has the potential for creating uncertainty and affecting the market," said Richard Spillenkothen, a former head of supervision at the Federal Reserve Board and now the director of governance, regulatory and risk strategies at Deloitte & Touche LLP. "To the extent that all of the questions are not answered this weekend, or the next several weeks," he said, there could be "market consequences."
To be sure, the Basel Committee is expected to give some sense of how far negotiations have progressed. Industry observers are hoping for details on final Tier 1 capital requirements, the size of a conservation buffer to protect the largest institutions from a financial crisis and how quickly Basel III will be implemented.
But even if the committee releases all those details, articulating the impact on individual banks will be difficult, observers said.
"You need to do it dynamically, not just based on today, or 2007 numbers, but rather in terms of looking ahead where the banks will put their assets in a still recovering financial market," said Karen Shaw Petrou, a partner at Federal Financial Analytics.
Some analysts have already tried to estimate the potential capital shortfall. A report by Barclays Capital said that the 35 largest U.S. banks will have to raise $115 billion to comply with Basel III standards. How fast they will have to raise that money is a persistent concern. Bankers have argued that the faster and higher they have to raise capital, the larger the hit to the economy.
"The question remains will the banks be able to adjust to these higher new levels of capital and still be profitable as they were before the crisis? That's the big question," said Tom McGuire of Barclays, whose division conducted the calculations.
Recent studies released by Basel last month suggest that having a longer transition period of four to five years would have a smaller economic impact than banks had previously estimated.
As such, regulators are likely to make the case that a more substantive transition period will offer banks the opportunity to accumulate retained earnings, mitigating any potential negative impact.
"The length of the transition period is a critical element to figuring out what individual banks will do and the broader effect on the economy," said a source close to the negotiations, who spoke on condition of anonymity.
Still, even if observers expect a longer transition period, most expect the final requirements to be tough. They point to the committee's report in August that concluded that higher standards would not damage the economy in the long term. "My own suspicion is the committee will adopt some stronger measures and use the analyses to justify why it should not have the negative impact on the economy as some have projected," said Gregory Lyons, a partner at Debevoise & Plimpton LLP. "These studies rightly or wrongly give them the justification to move back to higher ratios."
The most critical unknown is how high overall standards will be. Regulators involved in the Basel III process are setting multiple standards, including Tier 1 requirements and a conservation buffer designed to protect firms in the event of a sudden crisis. Media reports out this week have suggested a range of figures, roughly around 6% for Tier 1 requirements with a 3% buffer (and potentially an additional 3% countercyclical buffer) while sources close to the negotiations insist the final numbers are still under discussion.
If those figures are close to accurate, some expect banks to push back, arguing such standards are too high and would cripple lending activity. Many are likely to focus in particular on the conservation buffer, contending it should be lower.
"You'll see some banks fight back hard to argue that they can't retain earnings and attract capital all at the same time," Petrou said. "That's one of the real challenges with this conservation buffer. How do you attract investors and maintain yourself as a viable entity and not pay a dividend?"
Observers said banks' share prices could take a hit if dividends are curbed. "One of the allures of bank stocks has been a consistent dividend," Lyons said. "Anything that would impair their ability to do that could have a significant effect on the stock price."
Another outstanding issue expected to take additional time to work out concerns liquidity, including the net stable funding ratio.
Regulators have had an easier time arriving at the liquidity coverage ratio intended for short-term financial stress that lasts no more than 30 days, as opposed to the net stable funding ratio, which looks to ensure stable funding in the event of a longer period of stress.
For both, regulators are seeking to arrive at a ratio of 1:1 to make sure outflows are fully covered by inflows in the event of a run on the bank. In the case of the net stable funding ratio, however, regulators want to look at the entire scope of the balance sheet and place a liquidity value on all assets of the bank. That could mean banks would have a longer phase-in period for the net stable funding ratio, and a well-developed plan for the liquidity coverage ratio.
"There are a lot of things that need to be considered," said a source familiar with a regulator's position. "We want to make sure we understand the impact of how we factor everything and categorize everything to ensure there are no unintended consequences."
