New Basel III rules: additional capital requirements have an impact on the economy

In response to the financial and economic crisis of 2008, a revision of the Basel standards was performed with the aim of making the financial sector sounder and more risk resilient. The first phase of the reform focused on strengthening capital and liquidity buffers. The final elements of the reform package focus on banks' risk management. The European Commission will publish a legislative proposal in the autumn of 2021 to implement the final Basel III rules. It is important to strike a balance between capital requirements and the financing of the economy.

The stricter rules are not without impact on the financial sector and the economy. Research commissioned by the European Banking Federation shows that the final Basel III standard will increase the capital requirements of European banks: according to the report, this would amount to an additional EUR 170 to 230 billion in capital needs.

It is essential to emphasise that Belgian banks have already made great efforts to achieve a resilient banking system. Not only by building up robust capital buffers, but also by implementing reliable internal risk models. The structural improvement of risk management was also confirmed by the European Banking Authority in its annual benchmarking exercise.

Higher capital requirements for banks translate into higher costs, as equity is a more expensive source of funding than debt. When banks are already highly capitalised, these higher costs can have negative implications for the economy. In practice, this could lead to a higher cost of credit, possibly reducing demand for credit and investment.

It is necessary to investigate the most appropriate option for implementing the final Basel III rules. Therefore, the Belgian banking sector makes a few concrete proposals to better align the reforms with the Belgian economy. The proposals, technical in nature, are intended to reduce the significant increase in banks' capital buffers and to limit the negative impact on the financing of the public sector and unrated companies. Maintaining optimal bank financing to SMEs is obviously particularly important in these post-covid times.

In other words, how to implement the final Basel III package without significantly increasing the capital requirements for banks, and thus limiting the impact on the economy and customers?

Because even if Belgian banks are well prepared and have made the necessary efforts in recent years to increase their resilience, the reforms cannot be transposed blindly into European legislation. Implementation must consider the economic impact of increased capital requirements and the characteristics of the Belgian market. Moreover, the banking sector still has to deal with the consequences of the corona crisis as a priority, so an additional negative shock is far from desirable.

Both to ensure economic and financial stability, the impact on capital requirements should be as limited as possible. In this way, the cost of credit for consumers remains within limits. In line with the Basel objective, banks always remain alert to potential risks and maintain sufficient reserves to be able to absorb shocks and continue to guarantee the granting of credit.