Abstract
This study outlines a methodology for mapping the increases in capital and liquidity requirements proposed under Basel III to bank lending spreads. The higher cost associated with a one percentage point increase in the capital ratio can be recovered by increasing lending spreads by 15 basis points for a representative bank. This calculation assumes the return on equity (ROE) and the cost of debt are unchanged, with no change in other sources of income and no reduction in operating expenses. If ROE and the cost of debt are assumed to decline, the impact on lending spreads is reduced. To recover the additional cost of meeting the December 2009 proposal for the Net Stable Funding Ratio (NSFR), a representative bank would need to increase lending spreads by 24 basis points. Taking into account the fall in risk-weighted assets from holding more government bonds reduces this cost to 12 basis points or less.
Highlights
Background on the December2009 regulatory proposalsDuring the 2007-2009 period, the global financial system was destabilised and the real economy suffered after banks across a range of countries became illiquid or insolvent following major losses on their investments.7 The scale of the recent global financial crisis has been compared to the bank failures and GDP contraction of the Great Depression and the Interwar years of the 1930s
While the Basel Committee on Banking Supervision (BCBS) proposals outline two liquidity requirements, this study focuses on the Net Stable Funding Ratio (NSFR)
This study has presented a methodology for mapping the possible impact of higher capital and liquidity requirements on bank lending spreads
Summary
During the 2007-2009 period, the global financial system was destabilised and the real economy suffered after banks across a range of countries became illiquid or insolvent following major losses on their investments. The scale of the recent global financial crisis has been compared to the bank failures and GDP contraction of the Great Depression and the Interwar years of the 1930s. To meet the requirement for more and higher-quality capital, banks need to increase common equity relative to total assets. The LCR cannot be estimated directly as it requires details on a bank’s expected cash outflows over a one-month period The NSFR addresses maturity mismatches between assets and liabilities It establishes a minimum acceptable amount of stable funding based on the liquidity characteristics of a bank’s assets over a one-year horizon. To meet the NSFR, banks are expected to hold more high-quality, liquid assets, financed by more stable deposits, more equity or longer maturity liabilities. This study discusses these strategies and estimates the cost to meet the NSFR. To the author’s knowledge, this is the first academic study of the cost to meet the NSFR
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