New liquidity and funding requirements that are being imposed on global banks under the Basel III capital adequacy regime will be a positive for banks’ credit quality, notwithstanding the compliance costs, according to a new report from New York City-based Moody’s Investors Service, Inc.
Retail banks, and other financial institutions that are largely funded by deposits, will particularly benefit from the new requirements, the report suggests, whereas banks that are more reliant on wholesale-funding will face significant costs and may alter their business structures in response.
“The new requirements stipulate that banks hold higher balances of more-liquid assets and fund less-liquid assets with more stable funding so that they’ll be better able to withstand any one-off or market-based liquidity shocks,” says Laurie Mayers, a Moody’s associate managing director. “But the emphasis on funding stability and asset liquidity could also hurt profitability as a result of the impact of holding lower yielding liquid assets and extending out funding maturity profiles.”
As a result of the requirements, banks are trying to minimize their reliance on uninsured financial liabilities, such as interbank and short-term money market funding, Moody’s says, and banks are enhancing the stability and duration of their funding to better match long-term, less-liquid assets such as loans.
Banks are also increasingly looking at retail deposit funding to fund lending growth, Moody’s says, as retail deposits tend to be more stable. Competition for these deposits is intensifying, Moody’s adds.
Higher funding costs and lower asset yields will erode profitability “if banks cannot compensate by re-pricing products or cutting costs,” Moody’s says.
Institutions that are more focused on corporate and institutional clients will have to adjust their business mix and may need to exit less profitable client relationships to maintain their margins, says Moody’s.