By Todd Alton, Vice President, Credit Research
Basel III and Local Government Investment Pool Management...
Dodd-Frank set into motion a comprehensive set of financial regulatory changes referred to as Basel III. which is intended to be “a comprehensive set of reform measures developed by the Basel Committee on Banking Supervision (and adopted by the United States Federal Reserve Bank)., Source: www.bis.org).
The end goals of Basel III are three-fold:
1.) “to improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source;”
2.) “to improve risk management and governance;”
3.) “to strengthen banks' transparency and disclosures.” (Source: www.bis.org)
The first phase of Basel III became effective for the largest internationally active U.S. banks on January 1, 2014. The second phase of the Basel III Comprehensive Capital Framework is scheduled to go into effect beginning January 1, 2015. This phase will affect the “standard approach” or “non-advanced approach” banking organizations.
The Basel III risk-based capital rules will apply to all banks and savings associations (and holding companies with greater than $500 million in total assets).
The rule will require banks to hold higher levels of regulatory capital.
The new risk-weighting regime will require institutions to maintain significantly higher capital reserves when they hold assets considered to have higher risk exposures.
In certain circumstances, some items that were previously included in a bank’s capital ratios will now either be reduced or eliminated from the calculation, thus reducing depositors’ overall capital protection.
Potential effects on banks that “pay up” for deposits (i.e. fund themselves with hot/volatile money):
Margin compression: more capital held equates to less productively deployed capital and thus lower earnings which when added to the higher costs of the deposits equals compression.
Acquiring assets with yields sufficient enough to “pay for” the increased capital charge will result in the bank necessarily taking on either greater interest rates or credit risks.
Banks still willing to pay the highest deposit rate in their trade areas will be those that have to replace wholesale funding and those that are trying to grow rapidly.
In the final analysis, as a public funds investor, what are the pros and cons of depositing the public’s funds in a bank that is paying top of, or above, market deposit rates? . . . AND is the risk/reward profile in balance, a prudent allocation of funds, and an appropriate discharge of our fiduciary duties? And ultimately, are the extra few basis points really worth the risk, even with collateral?Please feel free to contact the management team at Public Trust Advisors with any questions regarding BASEL III and its implications on your local government by emailing us at firstname.lastname@example.org.