Despite Basel sticker shock, banks soldier on

A new study by the Boston Consulting Group finds that banks globally face a $450 billion (€350 billion) Basel III shortfall, as reported today in the Financial Times. According to the study, banks in Europe have the biggest gap, more than half of the total.

While stunners like this make good headlines, what’s often ignored is the real progress banks are making in this area. At our FICO World 2011 conference last month, which included experts from FICO as well as Stephen Morris, CEO of Global Basel Analytics Corp and Rebecca Lucas from the Financial Services Authority, we discussed several emerging practices and ideas.

Some banks are considering issuing more stock/shares than they have in the past.  Deposit activity has been curtailed recently, and it’s harder than before for banks to find capital to lend using their “tier one” rates, so this tactic could raise new resources to re-invest and drive revenues.

Banks will also want to consider whether or not they should allocate capital across their portfolio differently; for example, perhaps moving capital from cards to fixed loans will improve return on equity and capital efficiency.  This could especially prove true for European banks.

Banks are focusing on integrating their Basel III compliance activities with their everyday operations more seamlessly.  Not only does this drive efficiency for the business, it ensures that the best practices in data warehousing and risk assessment needed for Basel are put to good use for business as usual. This makes regulators view Basel III implementations more favorably when they conduct audits.

We’re starting to hear a lot from retail bankers in the US that Basel III may place limitations on how well they can compete globally. However, the new regulations have given many consumers confidence in the safety of their money in a US bank.  Ultimately, what’s good for the consumer is good for banks and the rest of the economy.

Finally, the FT article skeptically states that “some banks may also seek to cut their RWAs by tinkering with the models they use to measure risk, a process known as ‘optimization’.” While there may be some less scrupulous tinkering, the general practice of refining risk models so as to capture a more accurate picture of risk — which may reduce capital requirements in bad times — is sound, not sneaky. In fact, it’s downright essential since it helps deal with the procyclicality problem.

The media loves a good scare story, and certainly our banking clients are concerned about how additional capital rules will impact their lending. But let’s not lose sight of the progress banks are making toward complying with Basel, and using its guidelines to improve their operations.