Global banks may need to raise US$566 billion to satisfy Basel III: Fitch

New capital rules could restrict the ability of banks to increase dividends or undertake share buybacks

By: James Langton
May 17, 2012 May 17, 2012
11:40

Fitch Ratings estimates that the 29 banks that have been designated as systemically important financial institutions might need to raise approximately US$566 billion in common equity to satisfy new Basel III capital rules by the end of 2018.

Fitch says that while full Basel III implementation will not occur until 2018, global banks will face both market and supervisory pressures to meet these targets earlier. The ratings agency says that US$566 billion represents a 23% increase relative to the institutions’ aggregate common equity of US$2.5 trillion, and it notes that this obligations could restrict the ability of these firms to increase dividends or undertake share buybacks.

Without issuing additional equity, Fitch says that the median firm would be able to meet this shortfall with three years of retained earnings. Banks will likely aim to meet these capital shortfalls through a variety of ways, Fitch suggests, adding that in addition to retaining future earnings, the may also sell, or wind down, exposures that are subject to higher Basel risk-weights.

These higher capital requirements will also weigh on returns. Fitch projects that the Basel III capital rules could imply a reduction of more than 20% in large banks’ median return on equity, from about 11% over the past few years to approximately 8%-9% under the new regime.

For banks that continue to pursue mid-teen ROE targets (e.g. 12%-15%), Basel III creates potential incentives to reduce expenses further and to increase pricing on borrowers and customers where feasible, it adds.

“Since it is impossible for regulators to perfectly align capital requirements with risk exposure, some banks might seek to increase ROE through riskier activities that maximize yield on a given unit of Basel III capital, including new forms of regulatory arbitrage,” said Martin Hansen, senior director, Fitch Macro Credit Research.

For riskier activities, which are subject to relatively higher capital charges, Fitch says that Basel III could increase borrowing costs, promote a shift to securitization and capital markets funding, or cause a migration to less regulated segments of the financial system, including ‘shadow banks’.