This week the Basel Committee on Banking Supervision (BCBS) published the results of its twelfth Basel III monitoring exercise, looking at how a sample of banks are coping with the more stringent regulatory framework that came out of the financial crisis.
In its assessment of the Basel Committee’s latest exercise, the European Banking Authority concluded that European banks were shy of just €1.7bn of common equity tier one (CET1) capital, assuming full implementation of the CRD IV-CRR and Basel III framework. They were only missing €3.6bn of tier one capital too, and €5.1bn of total capital.
In on page 20 of the report, the EBA presents a rather striking diagram showing how European banks have filled up with more than €400bn of fresh capital since June 2011, nearly eradicating their shortfalls in every type of capital, even as the asset side rules have become more stringent.
It has been a long and slow process asking banks to raise a mountain of new capital and defining how those forms of capital should look. Indeed, the BCBS first proposed its Basel III framework nearly eight years ago in what was then referred to as a “regulatory tsunami”. We didn't know the half of it.
But banks in Europe are very nearly there on the overall numbers. Now, they are beginning to work in earnest on the next stage in the process — optimising the cost and composition of the capital stack.
The evidence is already plain to see in the financial institutions bond market, in which issuance of non-preferred senior bonds has hit a total volume of close to €25bn in just 10 months. Billions more debt will likely be issued in the format, which was invented as a cost-efficient way of raising explicitly loss-absorbing debt securities for the total loss-absorbing capacity (TLAC) rules and Europe’s minimum requirement for own funds and eligible liabilities (MREL).
And structuring teams are even thinking about coming up with new types of liabilities to help banks make their capital structures more efficient. GlobalCapital wrote this summer about BNP Paribas' design for a new debt product that would absorb losses at an early stage under stress and could potentially replace expensive CET1 resources on a lender’s balance sheet.
One capital solutions banker had a succinct way of describing the situation that banks are moving into: “They have the carrot, but they no longer have the stick”.
In other words, European financial institutions are less worried about the regulator beating them with a stick because they are undercapitalised. Most of them are close to filling out their balance sheets with 1.5% of their risk-weighted assets as additional tier one (AT1) capital and 2% as tier two, for example.
They are instead worried about how they might be able to lower their overall cost of capital while remaining compliant with the relevant regulations, allowing them to dish out more carrots to their shareholders.
Barring another overhaul of capital adequacy frameworks or a particularly punishing final implementation of the Basel III reforms, it's time to move on, and change the conversation.