Basel III – A Guide to Basel and what it means for banks
Basel III regulation affects lending from banks. Alternative finance and ‘fintech’ encompass many different elements which are incorporated into lending platforms; it is these lenders that may be affected by the Basel regulations. Prior to looking at this change it is important to understand where we are in the alternative finance cycle.
Many in the world of investment and finance generally talk about the ‘fintech’ bubble, high valuations and replacing the banks. We work at the coalface of the alternative finance market and see that Europe is at an interesting point in the curve or cycle. It is true that alternative lending was phased in with a highly ambitious aim of replacing the banks; this was post 2007 when the general view was anti-large financial institution and capital adequacy requirements increasing. The phase in of alternative capital providers for various structures of lending were mainly grown in the private market and more recently institutional capital has moved in. This has in some respects tied some alternative finance providers to back-to-back requirements or policies and so has been restrictive in some respects, but has also facilitated growth.
What is the effect of Basel II and Basel III?
The Basel Committee on Banking Supervision decided to phase in Basel III from 2013 to 2019, in order to build on the Basel II regulations. The aim was to increase the hold on risk, regulation and supervision in the banking sector. A main focal point of the regulations is capital requirements in the banking world, which will inevitably impact borrowing costs. Some estimates put the additional capital required by the European banking industry to comply with Basel III at around 700 billion euros; which will reduce the return on equity and mean that banks move away from ‘riskier’ asset classes.
Why are banks regulated by Basel II and Basel III?
The broad aims of the regulation are to retain the banks’ solvency and tighten risk requirements. Thus, it builds on the Basel II capital adequacy requirements, which limit the amount of assets that a bank may have in relation to their capital. The reason for this, is so that any losses are managed and will not negatively impact the rights of creditors and depositors.
The focus on absorption of losses means that banks are required to have certain risk buckets of capital and a required size of such capital. There are three main tiers of capital; when looking at assets a bank must concentrate on the value of all of the exposures that it faces and a risk weighting is applied depending on the asset type. Thus, an amount of the bank’s regulatory capital must be allocated to each loan and this restricts the amount of business that a bank may enter into. This means that there is a cost in relation to the capital adequacy requirements of any loan being advanced.
The regulations have increased in specification and sophistication; to calculate risk weighting there will be a concentration on the type of counterparty, credit rating; security or risk mitigants in place and regimes for specific areas of finance. Alternative calculation methods with other risk weighting models will also be used.
Basel II allowed the capital charge of a loan to vary during its life. It would look at the credit rating of the borrower and the loan to value throughout the life of the lend. Risk weighting can also be amended if there are regulatory changes. Basel 3 has built on this, as there is an 8 per cent minimum ratio of capital to RWA. The capital requirements are higher and stricter regulatory deductions for calculating Tier 1 capital with tougher requirements for capital instruments, which are not common equity. In relation to the tiers of capital, the innovative features introduced to lower the cost of raising tier 1 capital are to be done away with. Tier 2 capital is to be simplified and tier 3 capital is to be phased out.
Where are the charges of capital and what’s the capital conservation buffer?Two capital buffers are being added – a capital conservation buffer and a countercyclical buffer. There is a general risk shift from depositors to bank employees and shareholders. In the event that an institution does not have the required capital buffers in place, Basel III may prevent the bank’s ability to distribute earnings.
The capital conservation buffer is to come in by 2019 and is intended for banks to maintain capital levels needed in the event of a sector-wide downturn. The countercyclical buffer is subject to consultation and has the aim of being implemented by national supervisors at times of rapid credit growth in a specific economy, with the aim of slowing such growth.
There is going to be increased capital requirements and minimum liquidity levels. It is presumed that there will be a reduction of rates on retail deposits; staff compensation will be reduced; and margins will be heightened on other products. Lending rates will also reflect these new costs, but in the event that this can’t be fed into older facilities then existing rates of return will be lower.
Why increase regulation of banking?
The aim is to reduce the risk of banking collapse at the institutional level and system wide shocks seen in recent years. The risk based capital adequacy framework means that at its very basic level, the greater ‘risk capital buffer’ needed, the less that a bank can deploy to earn a margin. There will be cost of capital increases and due to the restrictions, banks will look for less risky loans to back. Therefore government debt will remain in favour when compared to more heavily risk weighted SME lending.
The above is contrasted with the light touch approach in relation to regulation when looking at alternative finance firms and their approach to lending with associated risk. Less capital is needed to cover any exposure. As an example, UK peer-to-peer lenders only need to have £20,000 of capital, which will increase to £50,000 in 2016.
Will Basel III rules spill over into the alternative finance sector?
We don’t think so. This would open up regulators to criticism of starving SME’s of finance and allow banks to run the market with their own tighter regulatory requirements. The bank referral scheme has been a positive step to not let this happen; businesses turned down for bank finance are being referred to alternative providers by financial institutions, which is a step towards positive policy.
It is suggested that under Basel III banks may have to hold twice as much capital compared to previously. Overdrafts are also beginning to be cut due to their re-categorisation and will be seen in the same way as draw down loans, so sufficient capital will need to cover the unlikely possibility of overdrafts being withdrawn simultaneously.
All of the above combines to make for poor reading for new SME bank borrowers; it is more likely that there will be less lending to keep the level of capital the same as it is presumed that there will not be a sudden influx of capital. Thus, the same level or risk can be retained. The general view of SMEs being higher risk, lower return, and the need of significant resources in order to process each case will impact on the availability of SME lending.
Will there be further investment in alternative finance?
A fear of those investors that try to look ‘ahead of the curve’ and fear coming into the alternative finance market ‘too late’ is that there are overpriced valuations. Many see that there will be consolidation in the industry as transparency will be seen in loan books and those without tough credit policies will be found out as many loan books go full cycle.
We see that regulation phase in will be slow; there are more partnerships with financial institutions and alternative finance will act as a flexible and necessary addition to the main banks. Alternative finance will be perceived as a bolt on and not a replacement.
10 Tips Private Placement Brokers Must Know
If you are trying to close a private placement deal, the number one thing you do NOT want is a broker chain. Over the first few years, it is tough for most people to even become direct to a private placement opportunity, given the thousands of brokers that exist in the business. To add to the problem, most private placement brokers think they have a real private placement program, but unfortunately, 99% of them do NOT.
Investor or intermediary, the growing “broker abyss” haunts us all, and with this new unsafe environment you must have a unique approach to achieve success. In this article, we will provide you with the insight you need to break through the wall of mediocrity, so you can start your life as successful private placement broker. First things first, let’s take a look at some tips to help you find other brokers, cut through the chains, and get DIRECT to a real private placement trader.
10 Tips for Private Placement Brokers
1. Define your Goals: You will always be more successful if you create goals, and have plans on how to attain them. Though this is a very basic concept, most private placement brokers simply “wing it”, expecting to close the deal of a lifetime. If you are organized and well spoken on the phone, clearly stating your goals, most brokers will “pass you along” to the next person without hesitation, or tell you they can’t help from the beginning.
2. Education is Everything: If you are NOT educated in the fine details of private placement, you will NEVER be able to know what is real. In addition, if you are improperly educated, you could easily meet one of the few traders in the world, and not even know it. Whether you are an investor or broker, education is the key to determining which brokers are wasting your time, and which may be on to something. If you call brokers out with the facts and get straight to the point, they will part like the “Red Sea”, and you will eventually be DIRECT with a “trader”.
3. Find a Trader you Believe In: If you are promoting a private placement program that you don’t truly believe in, you are wasting your time. People can sense confidence and shakiness over the phone, and in the private placement world, that is your main method of communication. Do yourself a favor and don’t try to put deals together until you are completely sure that you are representing something, or someone that is real. Once you find someone you truly believe in, and you emit that confidence to other brokers in the private placement world, you will usually get places much quicker.
4. Be Confident and Calm: As we have said before, all you really have in the private placement business is your ability to communicate effectively over the phone. If you are educated, calm, collected, and confident, you will be far more efficient in your private placement efforts than someone without these characteristics. Despite the fact that this approach is far more effective in gaining a favorable response from other brokers, most brokers you will meet are anxious, undereducated, and living on a prayer. Define yourself, your knowledge base, and your confidence first, and you will be direct to a real program before you know it.
5. Creative Networking is a MUST: The most common way for private placement investors and brokers to meet is via the Internet. Whether you search through investment discussion forums, or other similar sites, private placement websites can be very limiting unless you get creative. Though this may be a good place to start, it will NOT lead you to your dream of riches. To be effective, you must use a far more aggressive approach that focuses on contacting everyone in the private placement business at once (hint: email spiders), with a goal of establishing a large contact base to network within. Once you establish a large network, and gain some experience, you can start to develop relationships with the select few individuals that you feel are real, and start to put deals together. Remember, if you network aggressively, you should always have leads to work with 24/7.
6. Organize and Follow Up : What good are leads if you don’t assess and extract the full potential from them? When you meet a new private placement broker, investor, or trader, always note their contact information, and what your gut feeling is on them. Also, it can help to write a short summary of your conversation so you can begin where you left off next time you talk. You may say, “I can keep track of things without documenting it”. Well, if that’s the case, you are not networking aggressively enough. You should aim to have a list of over 500 contacts, and should follow up with them based upon the priority you assign to each person. Remember, in the private placement business people forget about you quickly, so follow-ups are VERY critical to developing relationships.
7. Have a Good Business Presence: If you have made the decision to work in the private placement world, you should first create a legal business entity specifically for that purpose. After you have a business, you can think about creating a website, or other unique material to differentiate you from the 100,000 other private placement brokers. Always remember, whether you’re on the phone or just sending a simple email, to be successful in such an elite business you must exude the utmost professionalism at all times.
8. Demand to Speak with Program Manager: If you are educated in private placement, and the broker you are speaking with knows it, it may be a good time to get aggressive. By nature, most people do not like confrontation. With this in mind, if you are someone who appears to be well-informed, qualified, and straight to the point, you will get DIRECT to a “trader” in no time. Unfortunately, most private placement brokers sit behind their computers and Skype each other, when they should be “taking the bull by its horns”!
9. Ratios are Your Best Friend: As we have briefly mentioned before, it is better to start off with “500 contacts” than “50″ in the private placement business. Though it may seem tough to sort through all of the “programs” that people are offering, if you are educated, you will know when you meet a real trader. Some methods to increase your ratios/contacts in private placement are: posting in forums, using email spiders to extract/send emails, creating a blog/website, networking aggressively over the phone, etc. Think about it, if you have 1000+ contacts in the private placement business, chances are you’re DIRECT to something real. Once you find what it is, you can cut your network down to as few as 10 people, and still be a millionaire.
10. Make a Commitment to Never Give Up: If you make the decision to be successful no matter what from the beginning, and never give up, you will eventually find what you were looking for. In contrast, if you say to yourself, “If I don’t close a deal in 1 year, I am going to quit”, you will NEVER close a deal and will feel your efforts were wasted. Being successful in the private placement business takes someone with fierce persistence, and a very vivid dream of success, which as we all know, are very rare characteristics in this day and age.
After reviewing the tips we have listed above, you now need to ask yourself three important questions whether you are an investor or a broker.
First, is my personality right for the private placement business?
Second, can I commit to being cautious, and not overanxious?
Third, can i agree to never give up until I succeed?
If you have a second, sit back and reflect on these questions in your head…
After you have done this, now ask yourself, am I willing to sacrifice years of my life, all for a far-fetched stab at success? Well, your answer should depend on the type of person you are, and your willingness to learn.
If you are the kind of person that sets goals, thrives in moments of pressure, and overcomes adversity easily, then you may have a good chance to be a successful private placement broker. On the other hand, if you are someone with wealth and are open to new ideas, then you may be the right type of person to invest in a private placement program.
In summary, whether you are an investor or broker, you will always encounter “daisy chains” and misrepresentation in the private placement business. Though we have listed some great tips above to help increase your efficiency and identify time waste, always remember, how you utilize the relationships you develop with other brokers will lead to your success, or demise.