09.09.2016

Philippe Brassac : BASEL IV, a real threat to financing for the economy

It made sense to beef up banking sector regulations in the aftermath of the 2008 crisis. Yet continually raising capital requirements could interfere with banks’ ability to lend to the economy.

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In France, banks provide between 60 % and 80 % of financing to the economy, and outstanding loans climbed 3.9 % in 2015 to hit a record €2.1 trillion. They supply a far greater share of funding than in the USA, whose economy is chiefly funded through the capital markets and features extensive use of loan securitisation, including on the now-notorious subprime segment.
France’s banks, then, have shouldered the responsibility of funding the economy. After massively increasing their capital and liquidity, they are financially sound. And their resilience is regularly demonstrated through stress testing.

However, I am deeply concerned about the work around the “Basel IV” measures currently being conducted by supervisors within the Basel Committee.

The proposed measures would be detrimental to financing of the economy

The Basel Committee is the body in charge of setting minimum capital adequacy standards and notably the level of capital that banks must hold against the risks inherent to their business, including credit, market and interest rate risk.

The committee’s members are currently working on reforms to the methods for calculating these risks. Given the scale of the proposed changes, the committee is not merely tweaking the existing Basel III framework but actually developing a fourth version of the Basel Accord. The discussions and work underway seem to be leaning towards measures that, if adopted, would have a dangerous impact by drastically curtailing banks’ financing capabilities. Specifically, the suggested measures would oblige banks to hold an even larger share of capital, which can only happen at the expense of their ability to finance the economy.

Growth, economic activity and jobs would all be affected

The equation is straightforward enough: banks’ solvency is measured using a ratio with capital as the numerator and the risks borne by banks as the denominator. If regulators double the ratio, it is exactly as though they had decided that for every €100 of capital, banks could bear half the amount of loans. The aim, however, should not be to continually make banks sounder, but to intelligently manage the necessary trade-off between ensuring safety and serving the economy.

But the Basel Committee itself estimates that the new increase in capital requirements could reach up to 40 % as a weighted average for market risk alone. The impact would be considerable. Sectors that are crucial to jobs would bear the brunt, including small and mid-sized companies as well as major French exporters, including aerospace firms to give just one example. Financing for infrastructure such as motorways, bridges and airports would be hard hit because the amount of capital needed for banks to fund such deals could increase more than fivefold in some cases. Real estate financing would also be affected because the proposed arrangements could threaten France’s traditional fixed-rate (rather than floating rate) lending system, in which loans are granted based on the borrower’s ability to repay – i.e. income – rather than on the value of the asset, which is the customary approach in English-speaking countries.

Europe and France would be more exposed than the United States

When it got started on this project, the Basel Committee ruled out a “significant increase” in the overall capital requirements placed on banks.
In July, the economics and finance ministers of the European Union (EU) reiterated the need to stabilise the regulatory framework for banks, calling for a study of the impact on different banking models and stressing that Basel IV should not place additional capital constraints on banks.
But a study by the IIF has shown that the requirements would rise substantially under the Basel Committee’s current proposals.

The EU cannot accept a massive increase in capital charges, especially since European banks would be considerably more affected than their US rivals.
In Europe, the banking sector provides 80% of financing for the economy, whereas in the USA, which has powerful pension funds and a fully-funded pension system, the markets provide the same proportion of financing. What is more, US banks, unlike those in Europe, do not keep real estate loans on their balance sheets, transferring them instead to Fannie Mae and Freddie Mac, two government-backed mortgage refinancing agencies that got a huge bail-out from the US government during the 2008 crisis. These fundamental differences in the financial models applied by Europe and the USA, coupled with partial application by US banks of Basel II, mean that Basel IV will have virtually no effect on US banks.
US regulators advocate their position clearly and with one voice in the decision-making bodies of the Basel Committee, while Europe’s many different representatives mean that European and French positions are not defended effectively.

Recent stress tests show that Europe’s banking sector is holding up well despite the crisis, changes in practices driven by the digital revolution, and the ever-evolving legislative environment.
But the reforms mooted by the Basel Committee could have a devastating effect on the sector by pushing up the cost of capital, forcing banks to look for new sources of yield, which could ultimately lead to the emergence of new risks.
Europe has made a commitment to growth and jobs through initiatives such as the Juncker Plan, the Digital Single Market and the Capital Markets Union. European banks are working alongside the EU to play their part. But at a time of global harmonisation in the banking sector, Europe must stand united and speak with a single voice when it comes to decisions that will have a strategic bearing on the financing of its economy.

Philippe BRASSAC

Chief Executive Officer of Crédit Agricole S.A., member of the Executive Committee of Crédit Agricole S.A. Philippe Brassac was appointed Chief Executive Officer of Crédit Agricole S.A. on 20 May 2015, member of the Executive Committee of Crédit Agricole S.A. A graduate of the ...