Jay, the EBA and BCBS Basel III monitoring results are out

The EBA and the Basel committee just published the Basel III monitoring results. Click here to view the results of the EBA monitoring exercise. Click here to view the results of the BCBS monitoring exercise.

Best is to describe the results using graphs, in this case from the EBA report. Note, these are results of banks on 30 June 2014. They show the impact of fully implemented Basel III on capital and Risk Weighted Assets (RWA).

Figure 5 from the report shows a remarkable increase over time in CET1 and a joint drop in RWA. It is good to see the CET1 ratios increasing. However, the drop in RWAs is likely the consequence of a heavy focus on the risk-based prudential framework. Banks will respond to CET1 requirements by de-risking: they will shed off risky assets, for example, loans to Small and Medium-sized Enterprises (SME’s). Instead they will keep assets with low risk-weights (sovereign debt, residential mortgages) thus choking off economies.

monitoring1This graph shows the drop in capital shortfall over the years. This is encouraging, though again it is a manifestation of what-you-measure-is-what-you-get. Measure risk-based ratios and banks will increase them.

monitoring2The next graph from the report shows banks’ reliance on Tier 2 capital (in blue). This is the result of an attractive definition of Tier 2 capital instruments. Banks have issued lots of Tier 2 instruments over the recent years. Tier 1, however, has been marginalised (yellow), perhaps because of the very tight definition of this type of capital.

Only since the introduction of CRD IV, there has been an increase in the amount of Tier 1 capital, but still, it is marginal compared to CET1 and Tier 2:

monitoring3 The leverage ratio is steadily increasing, see next graph. This shows banks’ and regulators anticipating the introduction of more robust leverage ratio requirements. Therefore, regulators shan’t be afraid to increase the leverage ratio requirements, as banks will be able to comply provided they are given time to do so.