The global financial crisis that hit in 2007 served as an eye-opener to all players in the economy. The effects of the crisis were felt worldwide, from the largest multinational banks to the man on the street.
Regulators embarked on a journey to strengthen regulation across all sectors, and the banking sector was no exception. While many banks faced financial difficulty and some collapsed, the effects were more widespread as the public also suffered as a result of the crisis. At the same time as taxpayers had to assist in bailing out banks, other effects such as unemployment and a reduction in GDP were also felt in the broader economy.
Although the effects of the crisis are slowly wearing off, it is important to dwell on the past to ensure a strong and healthy future. With hindsight, it is evident that the financial crisis had multiple causes, but the banking industry was at the heart of the financial crisis being accused as one of the key players in the financial crises. Banks such as BNP Paribas and Lehman Brothers paved the way for the crisis as they faced financial difficulty in 2007/8 following which a number of banks started to collapse with a domino effect.
The Basel Committee on Banking Supervision announced Basel III in December 2010 and this was implemented in the EU through the fourth Capital Requirements Directive (CRD IV) which was published in 2013.
CRD IV not only strengthened capital requirements for banks, but also introduced two new liquidity standards that banks need to adhere to, the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) as well as imposed stricter rules on reporting of liquidity risk.
It emerged from the financial crisis that liquidity was not given as much importance as other areas and banks faced cash shortages because they did not hold enough liquid funds. Liquidity should not only be seen as insurance but also as a prudential regulatory tool alongside capital.
The LCR aims to ensure that banks maintain adequate unencumbered high quality liquid assets for surviving 30 days of stress. The NSFR aims to ensure that banks have adequate stable funding to cover their obligations over a one-year period under both normal and stressed conditions, based on the liquidity characteristics of the bank’s assets and activities.
2014 proved to be a challenging year for banks as the new requirements were monitored by regulators on a quarterly basis. The LCR is being introduced in phases with the first phase applicable from January 1, 2015, requiring banks to hold an LCR ratio of 60 per cent (70 per cent from 2016, 80 per cent from 2017 and 100 per cent from 2018). NFSR will become applicable as from 2018.
CRD IV is expected to have a positive effect on the public following the recent financial crisis. A key benefit is that the new rigid requirements will ensure that banks maintain adequate liquidity to satisfy depositors’ demands immediately. The fact that there is some form of structure in regulation sends signals to the market that banks are actively working on strengthening their liquidity positions. The market should draw comfort from this and it should give investors and general public more peace of mind.
Should banks be faced with a similar situation as in 2008, they should be better equipped to absorb losses. Since the liquidity requirements emerge from the CRD, which is directly applicable to member states, this will ensure a level playing field throughout the banks in the EU. Harmonised requirements are typically more robust as they leave little scope for interpretation. This will also assist in reducing regulatory arbitrage.
Kristina Borg is an assistant manager at KPMG.