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ACT: BANKINGREGULATIONS This gives a total capital requirement of between 8% and 9.5%, as opposed to the 7% applying to all banks under Basel III. The IMF has calculated that even 7% would create an additional requirement of USD 360 m for the world’s 62 largest banks. The exact surcharge depends on which of the four categories of systemic importance the institution falls into. The financial institution’s balance-sheet total is one yardstick, and the Basel committee has recommended that four additional benchmarks be used: interconnectedness, global reach, complexity, and substitutability by other providers. In the United States, the Dodd-Frank Act defines a bank that is “too big to fail” as one with a balance-sheet total of over USD 50 bn. Below this level, it is not systemically important. At the international level, a more complex formula has been used which takes different business models into account, and is compatible with the Basel III rules. Although SIFIs initially rejected the criteria, they will now have to exceed them and they are starting to get used to their newfound status. Of course, increased solvency requirements will erode their margins, but this could be offset by the advantages of refinancing. The calculation is that as highly stable SIFIs, financial institutions will earn better ratings and achieve lower risk premiums than banks with less capital, thereby establishing themselves as safe havens for investors in bonds and certificates. There are also benefits for deposit-taking business because, as Deutsche Bank CEO Josef Ackermann points out, customers “would rather invest their money with SIFIs.” At first, shareholders were alarmed by the prospect of their companies retaining profits to create additional buffers or increase capital. Now they are starting to see the silver lining – this will make their investments more attractive and lower-risk. Dodd-Frank Act attracts widespread praise Whatever people think about Basel III and SIFIs, there is no doubt that the industry’s situation will change drastically – not just for SIFIs, but for all providers. There will be no generous transition periods; it will happen immediately. Banks without adequate capital and financing could be forced to withdraw from previously attractive areas of the market and pass on their expensive refinancing costs to clients, which will reduce their competitiveness. Conversely, the changes would create additional opportunities for financial services providers that revalue their businesses to allow for risks as part of an overall banking strategy. “It’s potentially quite a simple question,” says Udo Bröskamp, head of Roland Berger Strategy Consultants’ Competence Center financial services. “How do I make the best use of my capital in the future?” It’s potentially a simple question: “How do I make the best use of my capital in the future?” However, he says, the answer is more complicated because businesses need to take into account the indirect effects of the new rules and their own national laws. “Some countries have already pressed ahead on banking regulation, while others will take their time implementing it, possibly making creative use of the SIFI criteria to give domestic banks a temporary competitive advantage.” Adopting such an approach to industrial policy could do more harm than good. Non-SIFIs may think that lower equity requirements have given them a head start, but sooner or later they could be forced to maintain higher voluntary buffers to signify their solvency to the market, where the investors will not necessarily know how institutions have been classified by regulators. For example, big banks whose business is primarily domestic could have huge balance sheet totals but still be placed in lower categories, or left out of the equation altogether. If the experience of the recent financial markets crisis is indicative, it seems likely that a big domestic bank with its fingers in lots of pies could cause just as much damage as a SIFI if it crashed. There have been dire warnings that banks could simply shift their business to regions with more relaxed rules; however, this is largely a ploy by lobbyists. “In reality, there’s limited scope for regulatory arbitrage,” Bröskamp says. “First in terms of time, because rules tend to converge as the years go by, and secondly, geographically, because you can’t just move and take your customers with you.” 64 THINK ACT SEPTEMBER 2011
Photos: Imago Frankfurt: for banks in Germany’s financial center, size and importance are relative. Bröskamp believes that consistent global rules would be undesirable because they ignore conditions in specific markets. For example, Switzerland’s very high capital requirements send out a strong signal about the stability of its extremely powerful financial sector, which contributes around 12% of the country’s GDP. In the United States, the Dodd-Frank Act, which focuses on financial markets and SIFI regulation, was passed into law in July 2010, and has attracted a lot of positive comments from observers. They believe it tackles the root causes of the financial market crisis, bolsters Wall Street against future downturns, reduces the country’s exposure to systemic risk, and creates greater transparency and clearer responsibilities. As with any form of regulation, there has also been criticism of the downsides. This criticism is sometimes tinged with exaggeration, though it does highlight some of the long-term management effects of current banking and financial market regulation. Restrictions on proprietary trading have already caused departments to close, though some of this business has been shifted to hedge funds. Other banks are considering incorporating their own account operations into their asset management business, which could make client-driven fund management and market-making more competitive. “Like Basel III, Dodd-Frank is having massive effects on the management of capital, liquidity, risk and financing, process models and IT systems,” emphasizes Roland Berger partner Holger Dümler. “Thanks to the long lead times, banks were able to assess the attractiveness of their businesses in the new regulatory environment long before it actually happened. Armed with this knowledge, they could decide well in advance whether to adapt their strategies or shut down specific areas of their business.” THINK RUBRIK HIER The Dodd-Frank Act There is a great deal of overlap between the 849-page, 541-article US act and the future Basel III rules in areas like liquidity requirements, refinancing, and maximum leverage. Both systems seek to make derivatives-trading a regulated, centrally cleared market, but Dodd-Frank places more emphasis on rescuing the big banks, or at least allowing them to die quietly. THINK ACT SEPTEMBER 2011 65
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