Emerging markets to benefit from 'Basel gift'

A decision to relax Basel capital requirements for banks is overall beneficial for emerging markets – but watch out for the risks

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The announcement that rules on banks’ Liquidity Coverage Ratio (LCR) will be phased in by 2019 rather than abruptly implemented in 2015 sparked a rally in European banks on Monday, while some analysts say it is good news for emerging markets, especially Central and Eastern Europe.

The LCR was set up in order to avoid a repeat of the 2007-2008 financial crisis by ensuring that banks have enough high-quality, liquid assets to tide them over in case they are faced with net outflows of cash.

The initial rule of the Basel III banking regulations stipulated that, starting with 2015, banks should ensure that they keep a ratio of high-quality liquid assets of 100% of total net cash outflows over 30 days.

But on Sunday, regulators agreed that the minimum requirement will begin at a ratio of 60%, rising by 10 percentage points each year to reach 100% in 2019, “to ensure that the LCR can be introduced without disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity.”

Banks in the eurozone, which had invested massively in emerging markets during the boom years, are only two-thirds of the way through deleveraging, according to estimates by Ernst & Young. Some analysts believe the change in the rule will slow down this process.


Simon Quijano-Evans, strategist for EMEA at ING Bank, believes the relaxation of the LCR requirements and the widening of the criteria to include other assets among the high liquidity ones “should play a tangible part in supporting the global recovery story in as much as a full implementation by 2015 would have meant continued tight bank lending practice.”

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In his opinion, EMEA is likely to benefit most from this “Basel gift,” as Western European banks have been gradually cutting exposure to Central and Eastern Europe, where they had expanded rapidly during the boom period.

“At the margin, clearly any relaxation of requirements both for domestic banks in emerging markets and for international banks are going to help both domestic growth and global growth,” Peter Attard Montalto, emerging markets economist at Nomura, told Emerging Markets.

“But I think really given the slew of legislation the additional gold-plating that happened in many cases by national central banks, pretty conservative ones like in Eastern Europe, probably will mean that the effect will be minimal.”

“At the end of the day, the amount of time to the implementation of this means that it’s not any real help with the immediate growth problems.”

Montalto pointed out that in some emerging countries, the domestic rules were even more strict than the international ones and this discouraged banks from lending there.

He said deleveraging by Western banks was likely to continue regardless of the new rules, as it depended on “more structural issues” such as legislation and capital requirements from the eurozone and banks’ changing business models.

But, Montalto said, a lot of deleveraging “already got out of the way last year” and this year it would manifest rather as a lack of new investment by banks in emerging markets. 


Not just the extension in the LCR but other measures announced by the regulators on Sunday will benefit emerging markets, Patricia Jackson, EMEIA financial services partner at Ernst & Young told Emerging Markets.

“I think it’s definitely positive. If you look at things like trade finance, which are very important with emerging markets and cross-border trade they’ve made the requirements much less penal on trade finance,” Jackson said.

“They have reduced the extent to which the liquid asset buffer is being driven by different trade finance operations. If you’re carrying out trade finance, you have to hold a smaller liquid asset buffer than you would have had to otherwise, that reduces the cost of trade finance.”

“The lower cost of trade finance provides a knock-on benefit in terms of the cost of trade.”

For trade finance, the announcement said, the Basel III regulation will “include guidance to indicate that a low outflow rate (0–5%) is expected to apply.”

The outflow on fully insured deposits from companies, governments, central banks and public sector entities was halved to 20% and the outflow rate for non-operational deposits provided by non-financial corporates, sovereigns, central banks and private sector entities was cut to 40% from 75%. The interbank credit outflow rate was also reduced to 40% from 100%.

“In general there will be effects of the changes on the requirements on the cost of credit because the liquid asset buffer obviously has a lower return and so gets passed on in terms of the margin on lending that’s applied, so that’s quite important,” Jackson said.

“The size of the buffer has been cut substantially. They’ve reduced the outflows that are assumed on various deposits and liabilities that are used to fund assets, and that reduction in the assumed outflows will reduce the cost of lending,” she added.