BIS Publishes Speech on Impact of Basel II/III in Developing Economies

According to Mr. Punchoo, in Mauritius, Basel III implementation has been a gradual process. The migration to Basel III capital requirements did not prove challenging, as nearly 90% of the banks' capital base was already in the form of tier 1 capital. In addition to the capital adequacy ratio, BoM introduced a capital conservation buffer of 2.5%, with its implementation staggered over a period of four years. A first tranche of 0.625% became effective on January 01, 2017; thereafter, on every January 01, the capital conservation buffer would increase by a tranche of 0.625% until it reaches 2.5% on January 01, 2020. In lieu of the countercyclical capital buffer, BoM introduced macro-prudential measures to limit the build-up of risks in three key economic sectors, which had witnessed unprecedented growth rates. These measures took the form of additional portfolio provision and higher risk-weights for specific categories of exposures, debt-to-income ratio, and loan-to-value ratio (LTVs were removed effective July 06, 2018). The LCR requirement in each significant foreign currency and on a consolidated basis was increased to 70% on January 31, 2018 and will be gradually increased every year to reach 100% by January 31, 2020. He then described the four adverse effects of the more stringent regulations, which he suggested the audience may wish to reflect upon:

• The first remark highlights the growing recognition that the "one-size-fits-all" regulatory framework may not be optimal. Increasingly, in several countries, the principle of proportionality in regulation is being discussed and implemented. While there seems to be a strong case for proportionality in regulation, it is not simple to decide which features of Basel III should not apply and which features should apply to smaller banks. 
• The second remark examined the unintended consequences of stringent capital requirements of Basel III. He exemplified that one European bank—namely Barclays Plc—has already exited Africa, including Mauritius. As per the Barclays CEO's review for the Annual report 2015, Barclays Africa has become "non-viable economically under current regulatory capital rules." He further mentioned that Barclays UK has to carry 100% of the financial responsibility for Barclays Africa and receive only 62% of the benefits. It is worth noting that Barclays UK has also exited its retail banking operations in Italy, France, and Pakistan and sold its Wealth & Investment Management business in Singapore and Hong Kong. Two other banks are in the process of exiting the Mauritian jurisdiction, as the respective Groups review the business models, refocus operations on their core markets, cut down costs by running down their less profitable and non-core business lines, thus reducing their geographical footprint and investing heavily in technology to optimize capital within Group. 
• The third remark relates to the unintended consequences of the introduction of the Liquidity Coverage Ratio. Basel III restrictively defines liquidity as an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted easily and immediately in private markets into cash to meet liquidity needs for a 30-calendar day liquidity stress scenario. In Mauritius where there are not enough liquid assets, banks have to keep large amounts of cash with the central bank at zero interest rates, instead of interest-earning placements with banks abroad. This could adversely impact customers, with banks charging higher fees, charges, and commissions.  
• The final remark relates to the impact of Basel III rules on trade finance. Basel III could significantly undermine cross-border trade finance activities. Several provisions of Basel III, such as the leverage rule, risk-weighting requirements, and the liquidity rules raise the costs of banks' extending trade finance, which is already a low-margin business. The leverage ratio requires banks to hold top quality tier one capital equal to 3% of their total assets, including off-balance sheet assets such as trade finance commitments. In addition, because trade finance involves the importer's bank and the exporter's bank through a letter of credit, the changing risk-weight on loans between financial firms is likely to adversely affect trade finance. Finally, the liquidity rules, which require banks to match long-term obligations with long-term funding could also penalize trade finance.

Related Link: Speech

Keywords: International, Middle East and Africa, Mauritius, Banking, Basel III, Proportionality, LCR, Trade Finance, BoM, BIS