Is Basel III Good for Banking?

There are a lot of complaints about the complexity of the new Basel III rules, which increase minimum capital ratios, establish a new set of risk weights for certain assets and increase liquidity requirements. All banks and thrifts, plus thrift holding companies, are subject to the new rules. Bank holding companies also are included, unless they have assets of fewer than $500 million. But will the new rules be good for banking, when all is said and done? Bank Director asked a panel of experts to weigh in on the new rules, which were finalized earlier this year.

Is Basel III good for banking?

Peter-Weinstock.jpgMore and more, I find myself to be in [Federal Deposit Insurance Corp. Vice Chairman] Tom Hoenig’s camp. Regulations have become monstrously complex. The Basel III regulations are more than 900 pages. If the question is whether higher minimum capital ratios and liquidity requirements make sense, I would say sure, but 900 pages? Beyond the complexity, there is considerable administrative burden even for community banks. I laugh when I read what amount of time regulators say is needed to comply with new regulations. They must all be masters of Evelyn Wood’s Reading Dynamics. I needed over two weekends just to read the first 280 pages of regulation.

— Peter Weinstock, Hunton & Williams LLP

Jonathan-Hightower.jpgBasel III is good for banking in that it directs the industry back into the more conservative role of a traditional financial intermediary rather than the high growth, boom or bust mentality that was so pervasive in the industry in the early to mid-2000s. The Basel III rules, in a general sense, promote more modest risk-taking by banks. The rules also moderate growth through limiting leverage for those institutions that have more aggressive asset mixes. By doing this, the rules will help curb competition that is strictly based upon which institution is willing to take the most risk. Hopefully, these rules will lead the industry back into an environment in which the most successful institutions are the smartest, not just the most aggressive.

— Jonathan Hightower, Bryan Cave LLP

Lamson_Don.pngYes and no. People generally accept that banks should have had more capital prior to the recent financial crisis, but Basel III has clear weaknesses. The problem lies in recognizing that overly complex rules and prohibitively high capital levels can be incompatible with increasing economic activity or at least contribute to driving borrowers to the shadow banking environment. The key is to understand the interrelationship of new requirements in addition to Basel III, both national and international, both imposed by Dodd-Frank and independently by bank regulators, to recognize that the cumulative effect of those rules may be more onerous than at first supposed.

— Donald Lamson, Shearman & Sterling LLP

Luigi-DeGhenghi.jpgIt’s a mixed bag. Since all U.S. banks will be required to hold more capital, especially common equity, than under the existing rules, they will be more likely to absorb significant losses and thus may be less likely to fail. However, in order to raise or maintain additional common equity, banks still have to deliver attractive returns to their shareholders. The cost of additional capital, plus the compliance burden arising from more complex rules, makes it too early to tell whether banks will succeed without cutting back on the availability of credit. The Basel III rules also create disincentives for smaller U.S. banks to expand through M&A transactions instead of organic growth. That could act as a brake on consolidation and affect the competitive landscape between banks of different sizes.

— Luigi L. De Ghenghi, Davis Polk & Wardwell LLP

Zaunbrecher_Susan.jpgThe application and implementation of Basel III to community banks is unnecessary. Community banks were not the cause of the troubles leading up to the Great Recession. Then, as now, most healthy community banks have more capital than will be required in 2015. When deemed necessary for safety and soundness, troubled institutions often have increased capital ratios imposed on them by their regulators. This has not changed, nor should it. Basel III may have the undesired effect of driving more consolidation of healthy community banks because they will not be able to profitably keep up with increased regulatory compliance costs, new CFPB rules, information technology advances, along with maintaining higher capital standards. This will be our loss.

— Susan B. Zaunbrecher, Dinsmore & Shohl LLP

Robert-Monroe.jpgWe believe Basel III will be good for banking, so long as the rules are clearly set out. Basel III will require banks to maintain higher capital levels, even though there are changes to what can be included in Tier 1 capital.

— Bob Monroe, Stinson Morrison Hecker LLP

Stanford_Cliff.pngBasel III implementation risks pushing banks to pursue similar business strategies to manage their regulatory capital burdens (which contributed to the 2008-2009 systemic crisis as well). Regulators have pushed banks to adopt model risk management practices to ensure that each institution does not slavishly follow underwriting, valuation, or risk management models without routine and independent validation. However, these same model risk management principles have not been built into the Basel III standards themselves, which are static and risk similar effects.

— Cliff Stanford, Alston & Bird LLP

As Stock Prices Rise, Expect Slow and Steady Consolidation in the Banking Industry

2013-MA-trend-report.pngIs there a mad rush to consolidate the banking industry? The numbers would say no. Bank merger and acquisition (M&A) deal volume in the first half of this year is flat compared to the same time period last year. Aggregate deal value actually has fallen a little bit. Pricing on a tangible book value basis is flat.

That could soon change.

Investment bankers and attorneys attending Bank Director’s upcoming Acquire or Be Acquired conference in Phoenix, Arizona, say they are noticing a pick-up in deal-making discussions that could lead to actual deals in the second half of the year. In fact, the biggest deal of the year was announced in July when PacWest Bancorp agreed to buy CapitalSource Inc., both Los Angeles-based banks, in a combined stock and cash transaction worth $2.4 billion. If that deal had been announced in the first half of the year, aggregate deal value would have risen by about 50 percent.

The environment seems ripe for more activity: net interest margins and high regulatory costs are putting pressure on community bank balance sheets, providing incentives to sell. Buyers have seen stock valuations soar during the last year, which means more banks can afford to pay a premium to buy a bank and potentially overcome one of the biggest hurdles to M&A during the last few years: a lack of agreement between buyers and sellers on a price. Asset quality also has improved during the past year for both buyers and sellers. Capital levels at many banks are high. Basel III rules for U.S. banks and thrifts have been finalized, offering clarity on what capital levels will be required, therefore making it easier to do deals. In another sign of an improving economic environment, failed bank deals have been on the decline, and healthy bank deals have been taking their place.

The slow and steady economic improvement may be leading investors in publicly traded banks to turn their attention away from price to tangible book value metrics, and looking more at earnings accretion and growth potential in M&A deals. Still, regulatory concerns and compliance issues are having more of an impact on M&A than during the financial crisis, when the focus was on asset quality. Both buyers and sellers need to assess the potential for regulatory problems in any M&A deal, as well as closely assess the potential synergies and growth opportunities resulting from a combination. Banks in general are cautious, and investment bankers and attorneys are shying away from predictions of a coming wave of bank M&A. Instead, many predict slow but growing consolidation.

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