Reasons for Implementing Basel III and Its Costs Essay

The global financial crisis (GFC) was a painful wound that marked the 20th century. It was the greatest crisis the gentlemans gentleman has witnessed since 1930 (the great depression). It primary started in the United States and interruption then to the entire humans and caused a consider fit slowdown in most certain countries and has bear on the financial grocerys and the emersion prospects in create countries. It is cal lead the doub direct jeopardy crisis as it spread rapidly with a transmitt fitting performance to the former(a) countries of the world.Despite the efforts exerted by g everywherenments and central edges to rescue the providence from this huge recession by self-asserting fiscal and m mavintary policies, train in the macroeconomic puzzle aim dropped. This huge crisis wasnt the go away of a persons mis fritter except it was the result of cumulative effect of poor regulations from the financial institutions and from central banks, unregulated hedge f unds, multilayered mortgages and the over evaluation by the com prep atomic number 18er address firms.It first started by the bankruptcy of Lehman Brothers in September 2008 overdue to the large releasees they sustained on the US subprime mortgage market and was followed by the failure of the seventeen largest banks in the US the too self-aggrandising to fail and six hundred other banks in the US. The federal bank was urged to rescue the too big to fail as their failure would aim destroyed the whole world scrimping. The strong interconnectedness between the world countries through the stock market, foreign exchange and outside(a) trade led to a contagious crisis in the other countries.Houses bells in USA collapsed with a loss of $2. 4 meg during eight months hitting the chemical equilibrium mainsheets of banks unfastened to the housing sphere of influence, which affected the entire US financial heavens, and then, in turn, other actual and ontogeny countries. A sharp fall down in the international trade and in the international stock markets by 50% to 75% from their peaks occurred which resulted in a moderate in the treasure of investiture and an advance in the rate of unemployment. The USA lost equities worth $16. 2 trillion in 2008.Investment banks collapsed and the IMF began to support countries such as Hungary, Iceland and Ukraine. However the relate of the crisis on developing countries varied depending on their direct or confirmative trade links to crisis affected countries. Although governors claim that the global financial crisis didnt affect Egypt, we dis conducted that it affected the emerge markets heavily as exports and upper-case letter flow retain been lower than expected. The real gross domestic product growth of the emerging economies fell from 8. 3% in 2007 to 6. 1% in 2008 and just 2. 4% in 2009.As we cease see in the graph, Egypts gross domestic product has witnessed a drop of 2. 5% after the global financial cris is. as well as the weak financial organisations of the emerging markets volition take eld and social classs to restore and fewer funds would be available for investment and innovation. In addition the aid that these countries used to get from the large donors set to thole as advantageously as exports who decreased by 20% which explains the decrease of the gross domestic product. This financial crisis is non a shock that damaged banks and financial institutions but actually it damaged many lots lives.Although the worst of it appeargond to pass off in the past, its effects atomic number 18 sustainable and long lasting. Employment rate decreased sharply which reflected in an growth in the percentage of stack living under the poverty line. Around 120 million great deal are living on less(prenominal) than $2 a daylight and 89 million more on less than $1. 25 a day. Same scenario applies for Egypt we sess see in the graph that the unemployment rose from 8. 9% in 2007 to 9. 4% in 2009. This high poverty rate led to higher mortality rates, higher number of depressed and ill people.a nonher(preno bital) result of this high unemployment rate is a decrease in consumption, businesses impart downsize and more unemployed people volition be. It is a vicious steering wheel of recession. Thats why World Bank and financial institutions are urged to take on ways out of this crisis and to create constant financial systems that nourish the humanity from such disasters. To avoid a reoccurrence of a financial crisis with that expansion and to protect the human beings from its withdrawals the mission of Basel decided to reform the Basel II and to upgrade it to a stricter system with more regulations on the market.Basel committee consists of a group of banks representatives that coerce for once every three months to heighten the efficiency of the banking sector in a fair and consistent framework. They started by drafting Basel I in 1988, then upgraded it to a more sophisticated adept in 2006 and finally drafted Basel ternary in 2011. This latter is our concern in this term paper. Basel committee on banking supervision and the financial stability board, which consists of 29 members 2 non-voting and 27 voting, tailored Basel cardinal accord.All through 2008 and 2009 they studied and design the Basel triple requirement and revised it through extensive consultation over the year 2010. After the global financial crisis and after feeling its huge forbid impacts on people lives, the effectuation of Basel accord tercet became mandatory and the area that wont abide by it wont have ingress to loans nor from large donors nations, nor from commercial banks, nor from IMF and World Bank. Also these countries wont be allowed to issue any foreign derivatives.By the year 2013 each kingdom should be ready to start implementing Basel III requirement and meeting them on 2019. The Basel Committee designed some requirements to be met in set up to bear witness the flexibility of the banking sector and advance its ability to absorb shocks by beef up the regulative peachy framework, building on the three pillars of the Basel II framework. Basel III mainly consists of raising the quality and level of the hoodital base, to enhance bump capture and to contain excessive leverage and to introduce parvenue liquid standards for the global banking system.Basel III consists of an upgrading for the three pillars of Basel II. The first pillar consists of enhancing the minimum jacket and fluidness framework. Banks jeopardize exposures should be backed up by a high quality detonator base and avoid overrated capital. Concerning capital management, banks are asked to have a minimum of 4. 5% greens stocks of their risk-weighted assets (RWA) to ensure that they buns absorb risks interrupt, they should also raise their new capital conservation to 2. % of RWA to cover any unanticipated risks and a countercyclical caramel of 0% to 2. 5% by the January 2019. Banks should enhance their risk insurance coverage by strengthening the capital requirements for counterparty conviction exposures arising from banks derivatives, repo and securities financing activities. These reforms allow for help reduce systemic risk across the financial system and they provide incentives to strengthen the risk management of counterparty credit exposures. After the global financial crisis, the importance of conserving a countercyclical buffer rose.Thats why Basel III musical scores for crisis by conserving capital to build buffers for individual banks and the banking sector that can be used in stress and serve as a shock absorber instead of transmitter of risk to the financial system and the broader economy. During the financial crisis, a number of banks continued to make large distributions of dividend as a way to reassure investors although the sector was deteriorating which made individual banks and the sector as a whole weaker.Thats why Basel III introduced a framework that gives supervisors stronger tools to promote capital conservation in the banking sector. Also a leverage balance requirement is introduced in order to pin down leverage in the banking sector and help it to mitigate the risk of deleveraging process that can be harmful to the economy. The second part of the first pillar introductoryally consists of developing two minimum standards for funding liquidity. The first is the liquidity coverage ratio, which promotes the availability of sufficient high quality liquid assets for one-month survival in case of a stress scenario.Banks pull up stakes cover these liquidity quest through tier 1 assets which comprise of cash, central bank reserves and high- quality sovereign debt, and tier 2 assets which consists of high-quality corporate and covered bonds, with min AA- credit-rating and non-zero-risk-weighted sovereign debt. The second is the net unchangeable funding ratio (NSFR) which ai ms limit over-reliance on short term funding and encourage banks to fund their activities through longer term with a minimum of a year of stable pedigrees of funding on an ongoing structural basis.The NSFR should be covered first through tier 1 which is capital and liabilities with effectual maturity of one year or longer (corporate), tier 2 which consists of capital and liabilities with effective maturity of one year or longer (non corporate), stable deposits of retailers and itsy-bitsy business customers and finally through wholesalers who are the less unstable source of funding. Pillar two that should be followed by banks consists of enhanced supervisory canvas process for firm wide risk management and capital planning. profound banks are required to draft a code of governance for their banks and make sure that they abide by this code, that there is a derive insularity between management and ownership and they should also put a cap for the executives remuneration. Finally p illar three requires some disclosure requirements from banks to help improve transparency of regulatory capital and improve market discipline. A dependable settlement of all regulatory capital elements should be backed to the balance sheet in the audited financial statements. These are basically the requirement of Basel III. from each one countrys banks should show a complete abidance by its requirements by 2019. However these changes allow make up countries a deer price. Although the implementation of Basel III will protect the banking system from default and will enhance its efficiency, it will cost the global economy a deer price. We will first discuss the cost of Basel III implementation on the developed nations then on Egypt as a developing country. For the G3 United States, Euro region and Japan, the implementation of Basel III would subtract an annual average of 0. 3 percentage points from their growth path over the full ten-year period (2011-2020). gibe to the size and t he significance of the banking system relative to the economy and the extent to which they will need to adjust to meet the new requirements of Basel III, the Euro Area will be hit the hardest and the Japan the least. Especially during the transition period (2011-2013), there would be an indirect slow down in the employment resulting from the lower gross domestic product growth. First, although the US banking system recovered rapidly after the financial crisis build in the middle of 2007, the crisis created a considerable cast up in its liquidity and capital ratios.To perform the changes in regulation, the US liquid asset ratio should be increased to 22% in 2012, maintained at that level through 2013, and trimmed steadily back to 18% thereafter. To abide by Basel III requirement this will cost the banking sector net engage margin to be squeezed (a decrease in ROE from 12% to 10. 4% in 2020) which will be reflected in a higher impart rate and as a result a lower convey for bank credit, which will accordingly affect the investment, business will downsize, gross domestic product will decrease and employment as well.A heavy price for this regulatory change will be paid which is an increase in the number of unemployed people by 4. 6 million by 2015. Also the US should abide by NSFR requirement by greater reliance on longer-term wholesale funding rather than short-term. Second, the Euro Zone, the largest banking system in the world with a total asset of 31. 1 trillion at the end of 2009, will incur huge costs by implementing Basel III. By applying Basel III requirements the nominal GDP of the Euro Zone will end up about 853 zillion lower by 2020 with a cumulative loss of 4. 5% of the average annual GDP growth.As a result the Euro Zone will have about 4. 8 million less clienteles being created over the coming years. All these compulsory restraints on the banks are enough to keep the economy in a recession over the year 2014. This implies a loss in the nominal income and consequently a loss in tax revenue about 300 billion (3% of GDP). In addition, when banks boost their holdings of liquid assets and improve their risk weighted capital ratios, this means that they will favor banks lending to governments, which will cause a greater allocation of bank lending toward governments, and crowds out lending to the privy sector.Besides, Basel III proposal will have a negative number to bank credit flows to Emerging Europe (OECD2) in the years in the lead as lending them will incur more charges allocated to credit and because maintaining traffic operations in Emerging Europe would become more and more expensive. The third developed country is Japan which will suffer the less from applying these regulatory changes this is because Japans banking system stood relatively stable through crisis and the pain in the Japanese money market was minimal compared to others as they learnt from their crisis of 1980s.The regulatory measures that the Japanese took in the last decade would serve as a good road map for applying Basel III. According to Basel III the Japanese banks should increase their capital by issuing extra ? 15 trillion of score 1 ( common land) lawfulness during the five coming years, but they will case a conundrum which is that Japanese investors prefer buying debt instruments rather than equity and also the low profitability of Japanese banks makes the issuance of more common stocks unattractive to them.This means that banks would wage a high cost, as they will be forced to cut their balance sheets and downside deflation risks. Banks will also chitchat higher fees, require additional costs for financial operations, and they may as well reduce their size and their balance sheets by reducing repos, loans, trading assets and securities, which will affect pricing negatively. In addition, the Japanese economy will be negatively affected, as their average cumulative annual growth would decrease by 1. 5% by 2020 and their number of unemployed people will increase.The cost of Basel III implementation will be cypher by the effect of the weaker growth in credit and nominal income that will consequently weaken tax revenue (loss of 0. 6% of GDP) and compound the Japanese governments budget deficit and debt difficulties and will deepen deflation risk in Japan as well. Although Japan is the least country affected by this regulatory changes but the price they will pay take care to be price significant especially for an economy where the banking system did not perform poorly through the recent crisis, or reveal itself to be a source of global systemic risk.Not only developed countries will incur the costs of Basel III but also developing countries will do as well including Egypt. Most emerging market banking system are going to incur lower costs than right markets thats because their banking systems are well capitalized and maintain ratios of regulatory capital to risk-weighted assets well above the current 8% minimum of the Basel II requirements. Egypt exceeded the minimum capital requirements of Basel II (8% of RWA), as its capital requirement was 11. % of RWA, which may help it to have an easier time to abide by Basel III.Thats why an increase in the minimum requirement of two percentage points, to 10% of risk- weighted assets would not appear to be a significant burden on the Egyptian banking systems that is currently quite well capitalized. However a price should also be paid by the Egyptian banking system, as it has to increase it common stock from 3. 6% of RWA to 4. 5% of RWA which means that investors will get a lower return in comparison their high risk (lower profit by share).As the majority of banks wont be able to issue more capital, they will be obliged to decrease their RWA by having less banking services, by downsizing their branches, reducing their assets, decreasing their lending and terrific higher fees. Also Egypt will be challenged to meet the net stable fu nding rule requirements (NSFR), which may lead to an increase in its banks overall funding costs. Besides, the potential application of a leverage ratio to off-balance sheet assets such as letters of credit and guarantee for small and medium- surface enterprises and trade finance instruments could have a penalizing effect.Moreover, because Egypt has unstable economic conditions it ask to increase its countercyclical buffer from 0% to 2. 5% of RWA in order to account for any recession and it needs to raise its new conservation buffer from 0% to 2. 5% of RWA. These figures mean that Egypt would be obliged to raise its total capital by around 3. 5% of RWA in additional capital which will reflect in a decrease of Egypts GDP by 6% over 2013 to 2019. Egypt will incur an additional cost of Basel III because of the compounded effects generated by the indirect effects of Basel III application.Lending to emerging markets such as Egypt became a costly job for mature markets economies (lendi ng to NON OECD costs 50% risk), which may result in a shortage of Egypts liquidity and indirectly ostentation pressure would be untamable for food prices. Unfortunately, I have to say that after the glamorous mutation of the 25th of January Egypts costs of implementing Basel III will dramatically increase. Because the mutation resulted in a decrease in the Egyptian GDP y 6% in few months, the central bank is using aggressive monetary policy to increase consumption by increasing lending which will consequently cause a higher RWA and will put Egypt in a deeper trouble to apply Basel III requirements. Egypt will pay a triple cost, first the above stated costs of Basel III implementation, then the indirect costs caused by the mature markets who will decrease their lending to Egypt and finally the cost of the revolution that lowered our credit rating from a BB- to BBB+ (junk) which will increase our cost of borrowing from other nations.In my own opinion, Egyptians should wake up, stop riding and start building their economy by hard work, which should be reflected in a high productiveness rate that allows firms to increase their sizes instead of downsizing and generating job opportunities. I think of the central bank of Egypt (CBE) should start by giving all its heed to solve the current crisis and should seek the Basel committee and beg them to giving Egypt a larger period of implementation in order to be able to meet their requirements.To restructure the current web site of Egypt, the CBE should start by seek a source of funding in order to satisfy the basic human needs of food and shelter. The CBE could seek the IMF and large donors and urge them to take long term loans in order to rescue the current situation and avoid hunger. Another way to raise funding is to issue bonds in the stock market (unconventional monetary policy tool).This way CBE could obtain some necessary liquidity to import the needed food and to pump more money in the market to create a m oney likeness so that people start spending. Second, the CBE should start solving the real problem of the Egyptians, which is poor income distribution by giving higher return for raise office depositors and by extending their loans. Another way to have a better redistribution of wealth is to enhance the SMES to enlarge their investment and open up new job opportunities by enhancing commercial banks to lend them with low credit rate.I personally think that pumping money in the hand of poor people, although it is a costly process to raise salaries, but it is a rewarding one as the poor population is the one that will use the increase in wealth in consumption rather than savings and and then increase GDP growth. On the long run, after stability takes step forward in Egypt, huge reforms will be needed in order to rebuild the Egyptian economic system. A decrease in the inflation rate would be recommended.CBE could use its two conventional monetary olicy tools, which are to decrease t he discount rate and the LRR to encourage banks to give loans with lower touch on rates, and to minimize the inflation rise hence enhancing consumption and increasing investment and as a result a rise in the GDP will take place. Using aggressive monetary policy can help alleviate the current situation but only a fundamental reform of the educational system, and an efficient allocation of resources would help Egypt to take place among developed countries one day. Egypt is a country with rich resources and with a high labor force that if used efficiently could form a developed nation.