January marks the beginning of the phase-in of new higher minimum-capital requirements for U.S. banks.

This is referred to as the Third Basel Accord or Basel III. These standards are sprouting from the decision in 2010 by the Basel Committee on Banking Supervision to set new global regulatory standards for bank capital adequacy, stress testing, and market liquidity risk.

The standards of Basel III came about largely in response to the financial crisis and the problems many banks encountered during and after the crisis.

Bank for International Settlements describes in a publishing what the measures of Basel III aim to do:

  • Improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source
  • Improve risk management and governance
  • Strengthen banks’ transparency and disclosures

Basel III redefines Tier 1 capital, restructures bank liabilities and risk management, and introduces a new liquidity coverage ratio and net stable funding ration to boost banks’ liquidity. These requirements are designed to improve the quantity and quality of capital that banks must hold in reserve by enforcing higher capital ratios.

Banking experts have been particularly concerned with the effects of Basel III on the community banks. They caution that higher capital ratios and compliance costs, along with the resulting higher cost in capital, could have a disproportionate impact on community banks. So disproportionate that they are predicting hundreds (or even thousands) of community banks will be forced to close their doors.

We have already highlighted some of the risks associated with small business lending in our article titled “Problem Loans: When and Where Will They Come Out of Hiding? Looking Ahead at 2015… and Beyond” but in addition to that, Basel III introduces another area of concern.  Due to banks having to assign higher risk weights to small businesses, they must maintain a higher level of capital to support small business loans. This just adds to the list of disincentives for community banks to lend to small businesses.

Community banks who wish to continue to lend to small business will most likely be forced to consolidate their loan offerings into just a handful of homogenized small business loans. The result of this will be the banker’s inability to be flexible in order to customize loans to meet individual small business borrower’s unique needs.

If you would like to know more about how the new Basel III capital requirements will affect you, please give us a call at 471-881-0145.