by Nathan Douglas, IMMFA Secretary General
The banking system has been subjected to increased scrutiny over the last few years, and it is only now that we have more certainty on the future regulatory structure of this system. The principal change to banking regulation is the Basel III framework. Money market funds purchase a significant volume of bank debt, and are subsequently impacted by most changes which occur within banking regulation. Therefore, as banks change and adapt to the new Basel III requirements, money market funds will also have to change and adapt.
What is Basel III?
All banks are required to hold sufficient capital to allow them to operate, with the capital held intended to offset any risk associated with the business and activities they perform. In 1988, the Basel Committee, which comprised banking regulators from around the globe, published a set of minimum capital requirements which large, internationally active banks should adhere to. These requirements were revised in 2004 (the Basel II framework) as the obligations imposed on banks increased in maturity and coverage. However, this framework revealed some inadequacies when faced with a stressed financial system.
The Basel Committee thus instigated new discussions aimed at improving the robustness of banks, and in December 2010 published the Basel III framework. This framework, to which all of the major economies of the world have agreed, includes revised capital requirements which banks must follow, and for the first time, liquidity obligations. In combination, these requirements are designed to deliver a more robust banking system which is better able to withstand stresses.
Why is this important?
The changes which the Basel III framework will instigate are fundamental. The structure of a bank’s balance sheet will be significantly different post-Basel III, and banks will likely assess their business models to ascertain what remains viable under the new regulatory structure. Much of the initial focus of banks and commentators has been on the capital requirements within Basel III. These will see banks having to hold at least twice as much equity as they do today. With increased emphasis on equity, the appetite of banks to issue debt may be reduced compared to the situation today.