World banks will have to raise €350bn to reach Basel III capital requirements, study says

In a report on global regulatory reform in the banking sector [registration required], BCG said that banks must either raise the necessary capital or cut their balance sheets when new standards are introduced under the international banking agreement known as Basel III.

The report urges banks to consider both the regulatory and economic implications of their business decisions to enable them to prepare.

"Banks that can attract cheap but - from a regulatory perspective - stable funding will gain a competitive edge. Thus, a strong retail platform, together with efficient covered bonds and securitisation platforms, will be critical to success," the report said.

Overall, the 145 banks worldwide studied by the researchers had a shortfall of €354bn in the capital needed to comply with the minimum Basel III requirement to hold tier one capital equal to 7% of their assets adjusted for risk. Tier one capital consists in the main of shareholders' equity and disclosed reserves. The report said that the banks could also close the gap by reducing their risk-weighted assets by €5 trillion, or 17%.

Basel III provides a new international baseline requirement for capital, leverage and liquidity. Banks will have to increase both the quantity and quality of capital they hold, while accounting for higher levels of risk-weighted assets. The agreement's requirements will be officially phased in between 2013 and 2022, but BCG said that many big banks were already moving to comply. Most were aiming to achieve the standards by 2013, the report said.

However, European banks face additional hurdles as the annual stress tests conducted by the European Banking Authority (EBA) will bring forward many of the requirements. The EBA will require European banks to hold a tier one capital ratio of at least 9% by June 2012 in order to provide an additional buffer against the sovereign debt crisis.

Although the EBA's rules relate to a much looser definition of capital, the BCG said that the rules "extremely compressed" the timeframe for compliance. In addition, European banks were more likely to run into difficulty than those in the US as corporate clients in Europe generally go to banks rather than directly to capital markets for financing, the report said.

BCG said banks in the Asia-Pacific region were likely to find the new requirements less burdensome because they generally had stronger ratios for both funding and liquidity. Both the US and Asia-Pacific banking sectors face a shortfall of about €70bn – far less than their European equivalents.

European banks have raised €73bn in capital since the start of the financial crisis while taking other steps to improve their ratios by reducing risk-weighted assets and retaining profits, for example by not paying dividends, the report said. However, the Basel Committee on Banking Supervision has said it is likely that European banks will struggle to meet the requirements.

Basel III also introduces two new liquidity requirements for banks, relating to the amount of assets they must hold which can be readily converted into cash. In 2010, the Basel Committee estimated that the global banking industry would need an additional €1.7 trillion to comply with its requirements. European banks made up €1 trillion of that shortfall.

Earlier this week Bob Diamond, chief executive of Barclays Bank, told a committee of MPs that planned 'ring fencing' reforms recommended by the UK's Independent Commission on Banking (ICB) earlier this year would likely to cost the bank between £1bn and £2bn each year.

Appearing before the Treasury Select Committee to answer questions about the impact Sir John Vickers' proposals to split UK banks' retail and investment banking activities would have on the bank, Diamond said that any change would have a "negative" impact on Barclays. However, he stressed that the lender could "manage" the increased burden.

The Government will announce how it will implement Vickers' recommendations on Monday. The Chancellor has previously announced his support for ring fencing, which is intended to make it easier for the Treasury to step in and protect customer-facing activities if a bank gets into trouble.