The Impact of Basel III and its Implication for International Project Financing Harvard Case Solution & Analysis

Basel III

The Basel III Accord is the regulation for banking sectors which focuses on key factors such capital requirements, market liquidity, and stress test. The implementation of Basel III Accord is set to take place in the year 2019 due to the changes that were implemented in the year 2013. The idea for Basel III Accord had been developed due to the failure of Basel II in addressing the financial regulations in the financial crisis of 2008. The proposal of Basel III is rested upon addressing two key points highlighting to increase the liquidity of banks, and to decrease the bank leverage in order to toughen capital requirements. The major difference between the Basel I and II and Basel III Accord is that, Basel I and II were focused towards identifying Bank’s loss reserves. However, the Basel III Accord focuses on the different levels of risks associated with different categories of banks depending on their level of borrowing and deposits (Engelmann and Rauhmeier 2011).

Impact of Basel III

The impact of Basel III has been described in forms as qualitative and quantitative which have been described below:

Qualitative Impact

The qualitative impact is further divided into impact on individual banks and the impact on financial institutions which are discussed below:

Impact on Individual Banks

The intense regulations in the Basel III Accord will allow the weaker banks to exit from the market because of failing to achieve required capital. These regulations from the Basel III have been proposed due to the adverse economic conditions. The intense regulatory scrutiny options will lead to a decrease in competition because there would an increase threat of a new entrant. Basel III regulations are focused on increasing profitability and the increase of Return on Equity. This strategy would pressurize banking sectors to focus on their operating capacity and to increase their investments in order to generate high returns. Basel III also emphasizes on long term investments and funding than short term funding. The liquidity ratios suggested by the BCBS will pressurize the banking sector only to focus on long term investments (KPMG 2011).

Impact on Financial Institutions

The inter-connectivity between the banking sector and other financial institutions have been decreased due to the increased capital and liquidity ratios from the regulations. This regulation has reduced the risks of banking sectors through strict risk management rules and guidelines. Due to the implementation of Basel III have been extended, therefore this impact will reduce the effect of lending for the purpose of the increased capital requirement as mentioned before (KPMG 2011).

Quantitative Impact

The capital ratio requirement has been increased because there has been an increase of eligible capital requirements and risk-weighted assets. The capital ratio is defined as eligible capital divided by the risk-weighted assets. Therefore, the increase of pressure on capital requirements has directly increased the capital ratio as it is affected by Basel III Accord. According to a research, it has been noted that the increase in capital requirements will directly increase the market risk, the mitigations efforts and securitization (KPMG 2011).

Responses of Banks to Mitigate the Impact

Many financial institutions are positive to mitigate the risk on capital ratios through internal credit assessment approach to measure the performance of the bank. The increased pressure on the capital requirements has driven financial institutions to manage their capital portfolios effectively, which has also given rise to hedging strategies and eliminating the market risks. The portfolio strategy of banks is likely to change as they would have to redesign their business model. The continuous review of the portfolio strategy may also enhance firms’ awareness to the market offering (KPMG 2011).

Implication of Basel III for International Project Financing

The most general implication of the Basel III Accord is widely expected to be the increased lending cost for banks and a higher price factor for the loan market. A figure shown in exhibit 1 shows that the common equity will quadruple with the implementation of Basel III due to the increase of capital requirements. In the investment market, the element of common equity has great impact on the economy of a country. The hunger for capital in the banking sector will be increased in the market. A research report indicated that the European banking sector would have to gather an additional fund of €1050 billion, whereas, the US market would have to require an additional €600 billion in order to imply with banking regulations. The Basel III ascertains the implication on the central bank funding as it would decrease the availability of its funding, whereas, an uncertainty will preside over wholesale funding market (KPMG 2011).

The increase in the emphasis on capital requirements by Basel III will also affect the global banking sector in raising the capital.............................

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