With all that is going on in the changing world of finance, a new headline has emerged and is actively being talked about – Basel III Accords. You may find yourself asking “what does it mean?” or “why should I care?”
Let’s start with the basics. Basel I/II & III are a series of accords created by a committee of what is now the G-20 Finance Ministers and Central Bank Governors. The purpose of these accords are to set international capital standards for banks. The name is derived from their meeting place in Basel, Switzerland. In short, Basel I created a system for uniform standards around capital, Basel II sought to let the banks monitor themselves and in effect, lower capital standards. Then, the financial crisis hit, and recent talk of Basel III indicates that the pendulum may swing again fully to over-capitalize banks.
So why, as a small- or medium-sized business owner in the United States, should you care? The answer is that the actions that are being set in motion impact both the large national banks, and the smaller community banks. With capital standards rising and risk buffers being put in place to increase capital requirements, banks will be forced to reduce the amount of risk that they can take on. Less risk, means fewer loans, and higher costs associated with those loans.
If banks cannot leverage their balance sheets to the extent that they currently do, then a combination of less lending, coupled with more expensive pricing, will be needed in order to continue to attract capital for the financial industry.
The larger banks will shun riskier assets, and instead focus on what are considered assets with lower risk. Those needing lines of credit or commercial mortgages will find it more difficult to obtain these “riskier” loan types. Businesses without two-way relationships with their banks will find themselves out in the cold, as even some community banks will begin to shun certain one-sided “transactions” in favor of long-term commitments that involve the entire banking relationship – not only loans, but deposits, residential mortgages and the like.
One certain consequence is that the world of an endless credit supply, which froze up in the financial crisis, will continue to shrink. Credit will be rationed, and banks – in an effort to increase their returns – will have to reduce their costs. As credit losses directly impact a bank’s cost of doing business, those that pose a higher risk will be left in the cold.
So how do we sum up how all of this is going to affect you and your business? It has never been more important to have a relationship with your bank, and to be sure that your bank is committed to growing alongside you. For those at a national bank, I do not know how that is possible… For those with a community bank, when was the last time “you” asked some questions about whether or not you are in a relationship that is two-sided?