To Basle or not to Basle....

The agreement reached at the weekend to implement new capital requirements for banks is the next step on the road towards reforming our international financial system.

The key components of the agreement are that:
a) banks will be required to hold capital reserves of up to 7% of their loans as a buffer against bad and under-performing assets.  This is an increase on the 2.5% that has been the norm in the past.  And was the woefully insufficient amount that was the norm in the recent crisis.
b) the new arrangements will be implemented from 1 January 2013 giving banks and regulators plenty of warning and time to make the changes.  Already a number of banks have announced their plans to raise capital to this end.

If fully ratified by the G20 at their meeting in November,
the changes will create a more robust banking system - for the long term.  They will not create much change to improve short term growth prospects although although they begin to remove some of the uncertainty in the banking sector that might start to see less 'second guessing' and 'more lending' taking place on the part of the banks.

The main affect of the new arrangements - from a company point of view - is essentially to increase the cost of borrowing.   If a bank has to hold an extra sum of capital for each of its loans, then the margin it makes will decline.  As a consequence the cost will rise.  At the same time, a new era of increased liquidity - where banks are now holding and are required by the regulators to hold more liquid funds on their balance sheets - will reduce the quantity of credit available.

The new reformed international financial system will look very different over the medium and long term to that we were accustomed to over the last two decades.  Less credit and more costly credit will mean we will have to be much more efficient and effective in our use of external credit sources.  It will also lead banks to be much more focussed on meeting the real needs of customers if they are to prosper and grow.

It seems to me too that we will see a large degree of competitive re-positioning between banks.  Some will merge, others will exit specific markets.  How many domestic retail banks will we see in key US and EU markets within the next five years for example?  How will banks in China, India and other rapidly growing markets develop both within and outside their domestic markets?  The answers to these question will be driven partly by economic developments around the globe and partly by international agreements such as those made at Basle last weekend.    

The Basle agreement is just a play within a play.  We seem to be heading towards a 'happy ending', but there are many more acts to follow and I am sure many more twists and turns of the plot before we reach that catharthic moment.