Basel III will hurt smaller banks most

Basel III will hurt smaller banks most

Good morning and welcome to today’s foreign exchange market commentary on Friday, the 2nd of November.

Smaller banks across the board will find it difficult to run operations in near future. It is not because they have given loans to people who can’t payback or made bad bets on complex derivatives. Rather, it’s because of the looming Basel III regulations developed in the wake of the financial crisis.

Basel III, formulated to ensure minimum capital buffers for banks, is expected to mitigate the threat of systemic risk in the banking system by forcing them to hold more capital against riskier assets. But a one-size-fits-all approach that treats the international mega banks with far more complex operations the same way as smaller local banks is not fair, neither to the banks or their customers.

In the US alone, there are about 6,800 banks with assets less than $1 billion. They represent about eight percent of total assets but make up nearly 40 percent of small business loans. Smaller banks are already struggling with weak loan demand, low interest rates and thinning margins. The Basel III requirements may actually jeopardise their very existence. These banks, which have limited options to raise capital, will be left without many choices other than finding a merging partner. Studies suggest Basel III compliance costs will trigger a mergers boom, with 20-30 percent of all banks merging in the next 3-5 years. Needless to say, greater consolidation will mean fewer options for consumers and higher prices.

Smaller banks also tend to have smaller fees. Non-interest income (different service costs and fees) account for only 20 percent of total income for smaller banks where as it’s about 50 percent for large and mega banks. This translates into higher fees for consumers, lower rates on deposits and higher rate on borrowings. Also community banks mostly create loans in the neighbourhood they operate in, helping the community grow. Megabanks on the other hand, make loans to large corporations a priority.

Community banks don’t pose the same magnitude of systemic risk as large banks. They need regulation, but the Basel III capital requirements are too steep for them. The new capital requirements may end up creating more mega banks, thus aggravating the very risk it was supposed to control.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2464
GBP/US$ – 1.6088
GBP/CHF – 1.5046
GBP/CAN$ – 1.6038
GBP/AUS$ – 1.5492
GBP/ZAR – 13.9172
GBP/JPY – 129.26
GBP/HKD – 12.4632
GBP/NZD – 1.9482
GBP/SEK – 10.7472

EUR: The single currency has continued to weaken against the greenback over the past 24 hours with the EUR/USD pair falling to 1.2895. Statements by Bundesbank board member Andreas Dombret to German newspaper Die Welt that the central bank is hardly better prepared for the collapse of a major bank that it was before the financial crisis added to the euro’s weakness. The government doesn’t have any real solution to stop them from becoming insolvent, he added. The equity-tracking Athens General Index tumbled five percent after lawmaker Michalis Kassis left the socialist Pasok Party over EUR 15 billion in spending cuts and tax increases. Shares of the National Bank of Greece plunged 12 percent. We have the manufacturing PMI data across Europe due today. The euro is trading lower against the cable compared to last Friday’s close and the GBP/EUR pair opens at 1.2475 today morning.

USD: Stronger equities and improved risk appetites have driven the GBP/USD pair higher over the last 24 hours and the pair hit a high of 1.6176 yesterday after US ADP employment numbers came in highest in eight months. US ISM manufacturing PMI reading for October also improved to 51.7 from 51.5 in September. The Conference Board’s consumer-confidence index also surged to 72.2, the highest since February 2008. Weak UK manufacturing PMI for October failed to temper moods yesterday though the cable has failed to latch onto the gains overnight. Focus will remain on the non-farm payroll data from the other side of the pond in the afternoon. The GBP/USD pair opens at 1.6095 this morning.

Have a great weekend!

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