Analysts at Fitch Ratings estimate the 29 global systemically important financial institutions, or G-SIFIs, need to raise $566 billion in common equity in order to satisfy new Basel III capital rules.
The amount is 23% more than the institutions’ aggregate common equity of $2.5 trillion and will impact their return on equity. Together, they represent $47 trillion in total assets.
Basel III sets higher levels for capital requirements while introducing a new global liquidity framework. It is designed to ensure systemically significant banks possess enough capital to cover future risks, enhancing the regulatory framework adopted by Basel II.
The United States is making little progress in meeting those requirements.
Banks face both market and supervisory pressures to meet the targets, even though Basel III won't be fully implemented until the end of 2018. Banks will likely pursue a mix of strategies to address these shortfalls, analysts say, including retaining future earnings, equity issuance and reducing risk-weighted assets.
“Absent additional equity issuance, the median G-SIFI would be able to meet this shortfall with three years of retained earnings, which might constrain dividend payouts and share buybacks,” Fitch analysts say.
This capital increase implies a reduction of more than 20% in the G-SIFI’s return on equity from about 11% over the past several years to 8% to 9% under the new regime.
“Basel III thus creates a tradeoff for financial institutions between declining ROE, which might reduce their ability to attract capital, versus stronger capitalization and lower risk premiums, which benefits investors,” analysts say.
Banks that continue to pursue 12% to 15% ROE will face potential incentives to reduce expenses further and increase pricing on borrowers and customers.
“Since it is impossible for regulators to perfectly align capital requirements with risk exposure, banks may seek to increase ROE by favoring riskier activities that maximize yield on a given unit of Basel III capital, including new forms of regulatory arbitrage,” analysts say.