2013 marks the start of implementing the so-called Basel III package of measures in countries which are members of the Basel Committee on Banking Supervision (BCBS), including seven Alliance for Financial Inclusion (AFI) members. Other AFI members are likely to follow parts or all of the new accord in time.
The initial emphasis of Basel III is on increased capital requirements which aim to enhance financial stability by strengthening the prudential regulation and supervision of banks. Some reports have suggested that these requirements will require banks in various countries to raise and hold more capital, thereby leading to increases in interest rates and potentially shaving points off the growth rate in OECD countries at least. Countries may accept this tradeoff in order to avoid financial instability which has proven very debilitating for many. However, banks in many developing countries already tend to hold more capital and be less leveraged than those in developed countries so that the direct impacts of the changes in capital may be muted for these countries; instead, a recent report from DFID suggests that there may be indirect effects through changes in the behavior of local subsidiaries of global banking groups which do have to raise behavior and in changes in cross-border lending patterns by international banks to developing countries. Beyond macro-level effects, what if any is the linkage between Basel III and financial inclusion, which has also become a stated goal for a number of prudential regulators?
For the past two years, we at BFA have been working on a project called GAFIS with a group of five large retail banks from five different countries—all AFI member countries, and three are also BCBS member countries (India, Mexico and South Africa). GAFIS, funded by the Bill & Melinda Gates Foundation and sponsored by Rockefeller Philanthropy Associates, seeks to encourage partner banks to develop and rollout savings products which are suitable for low income customers. Part of the GAFIS program includes developing a clearer understanding of the business case for low value savings. It is in that context that Basel III may have an effect on financial inclusion—and it could be a positive one.
One linkage is this: Apart from the capital measures, Basel III also includes the implementation of two new liquidity ratios:
- The Liquidity Coverage Ratio (LCR), to be phased in from 2015, which requires that banks carry high quality liquid assets sufficient to cover an expected run off of cash under a defined stress scenario over a one-month period; and
- The Net Stable Funding Ratio, to be phased in by 2018, which requires that a bank hold stable funding as defined in excess of a required amount, calculated based on their asset profile, over a one-year period.
The definitions underlying these ratios involve considerable complexity; and GAFIS banks in the three BCBS member countries are even now reporting privately on the ratios to their supervisors. However, a common element is that in both cases, retail deposits—from natural persons and small businesses—are given favored treatment: for the LCR, retail deposits have a much lower run off rate (3-5 per cent versus 50 per cent for wholesale deposits) under stress scenarios, reducing the need to carry high quality (but low yielding) liquid assets; and for the NSFR, retail deposits are weighted highly (80-90 per cent vs 50 per cent for wholesale) in the calculation of available stable funds necessary to match longer term assets.
The effect in any particular market will depend on the structure of assets and liabilities of the banking sector: some GAFIS member banks anticipate little effect from these ratios, but in others, they could have material effects. For example, banks more reliant on wholesale deposits to fund their lending may be forced to change their funding mix by bidding for more retail deposits. This could raise the rates of interest paid on retail savings to customers, as well as raising the internal float rate with which bank treasuries compensate the retail banking units for raising them. If this happens, this will create a stronger business case for banks to take retail deposits. If banks cannot achieve the required liquidity ratios in time, they may be forced to merge with banks which do; this may have the effect of reducing competitive pressure in lending from banks which lend medium to long term funded by wholesale deposits.
Of course, raising interest rates—both external and internal—for retail savings does not in itself translate into more financial inclusion. Rich depositors already in the financial system may well be the biggest beneficiaries of these components of Basel III. However, certain GAFIS banks have already started to prepare for these implications and they say that they strengthen the business case for initiatives designed to increase the outreach of the bank into new segments of retail savers.
ABOUT THE AUTHOR
David Porteous is the founder and Managing Director of BFA, a consulting firm based in Boston. He is also an Associate at the Alliance for Financial Inclusion (AFI).
Categories: Measuring Financial Inclusion