Basel III and Its Implications for the World Banking System

Overview

The Group of 20 Summit scheduled for November in Seoul will provide a forum for a wide range of economic and fiscal issues, ranging from World Bank governance to fossil fuel subsidies.

The world's biggest economies cannot be said to have a common economic strategy, but they will be discussing action on a number
of common matters, including banks' capital structures, liquidity and exposure to risk.

The stated purpose of the G20 Seoul Summit is to create a foundation for balanced, sustainable growth in the global economy as the world emerges from the recent financial crisis. But what does this mean for the financial institutions that will ultimately have to implement and follow a more comprehensive set of regulatory rules in the future?

As this paper is going to print, it is now apparent that the G20 will defer final decisions on some of the key aspects of Basel III until 2011 rather than during this meeting. While this is perhaps not a surprise given the political make-up of the G20, debate will continue after this latest summit on the specifics of capital structure and on other critical issues such as establishing a methodology for identifying banks that are "too big to fail" - and what additional regulatory requirements will apply to this elite group.

Since the London Summit in April 2009, the Group of 20 leading countries (G20) has been working to reform financial rules in light of the ongoing global fiscal crisis. In parallel, the world financial system has been facing challenges on nearly every level. While banks' senior managements have grappled with important strategic issues, regulatory authorities worldwide are mindful of what happened, or nearly happened, to the banks within their purview. These regulators have, in many cases, been granted expanded powers and new enforcement "teeth."

More than ever, regulators are seeking to act in concert, cooperating to develop frameworks that extend across geographies. While the regulators' position is logical - systemic problems in one bank, or within one country, can clearly have a significant if not drastic impact on banks around the world - it has proven extremely difficult to define and agree, let alone impose a common standard on banks that have different starting points, that are accustomed to operating within different prudential guidelines, and have different expectations as to acceptable margins, compensation structures and disclosure requirements.

Given this complexity, and the outcomes of the previous three G20 forums, our expectation is that the clarity desired by many in the industry will still be lacking at the conclusion of the Seoul meetings. It therefore raises some interesting questions: Is Basel III a destination, or the next point along a longer journey? Will there be a level playing field across the banking sector, and, if so, when? And, by extension, until the rules are clear, is it advantageous for banking leaders to keep things as they are, or to put in place key components of the anticipated reforms before they are required?

From where we sit today, there are simply too many complexities and inter-relationships across the disparate geographies and economies which make up the G20 to believe that the timelines and/or requirements of the recently structured Basel III will accelerate or result in higher requirements for capital. However, we fully expect that additional requirements and modifications will emerge as banking institutions, economic leaders and political leaders work together to implement a solution that provides the stability desired without overly affecting the still nascent financial and economic recovery cycle.