The banking sector’s long-awaited “Basel III” regulatory reforms are due to be implemented at the start of 2027 after several delays, in a move that is designed to promote global banking stability, but which critics fear could have negative implications for African banks and economies. The Basel III reforms were first developed by the Basel Committee on Banking Supervision (BCBS) in the aftermath of the global financial crisis in 2008. The crisis started with the collapse of major US banks such as Lehmann Brothers but quickly spread throughout the world.
The idea behind Basel III was therefore to come up with new regulations that would prevent a repeat of this “contagion” and ensure global banks would be more resilient to future shocks.
The original completion date for the full programme – known as the “Basel III endgame” – was January 2022. The onset of the Covid-19 pandemic in 2020 led, however, to a year-long delay. The date has subsequently been delayed further: most major economies have said they expect to implement the reforms in full by 2027.
Basel III – stricter standards
The central reform introduced by Basel III is an increase in both the quality and quantity of capital that banks must hold. Financial institutions are also required to meet stricter liquidity standards, ensuring they have sufficient funds available at short notice to withstand unexpected shocks.
Under the new rules, banks must hold at least 4.5% of their risk-weighted assets in the highest quality form of capital, known as common equity tier 1 (CET1). On top of this, they must maintain 2.5% in a further “capital conservation buffer”.
In practice, this means banks must hold at least 7% of risk-weighted assets in core equity capital, forcing them to fund more of their activities with genuine shareholder money – rather than depending on excessive borrowing, a practice that contributed to the 2008 crash.
Basel III also introduces a 3% leverage ratio, requiring banks to hold capital equal to at least 3% of their total exposure, regardless of how safe those assets are deemed to be. This is meant to limit excessive balance sheet expansion and borrowing.
Furthermore, banks must hold enough high-quality liquid assets, such as government bonds, to survive at least 30 days of severe stress, under what is known as the liquidity coverage ratio (LCR). This is designed to ensure banks do not run out of liquidity, as many did during the financial crisis. More stringent rules will apply to the most globally significant banks.
Regulators have argued that these reforms are vital in ensuring a repeat of the 2008 financial crisis – which wiped out over $2 trillion from the global economy – is avoided. Erik Thedéen, chair of the BCBS, has said “a healthy, well-capitalised banking system can support an economy, even under severe stress… I don’t see Basel III as a burden – I see a compelling case to get it done.”
Unfair for African banks?
However, some analysts have raised concerns that these reforms, designed primarily as a response to a crisis that started in the United States and other Western countries, could have negative implications in Africa. The fear among some is that Basel III could impose unfair costs on African banks. Cumesh Moodliar, CEO of Investec South Africa, has warned that African financial institutions – which tend to operate in markets which have lower sovereign credit ratings and in which borrowing is therefore more expensive – will face higher costs if Basel III forces them to hold more capital in reserve.
This potentially puts banks in more developed markets at an unfair advantage, since they are mainly able to raise money more cheaply in their domestic markets. Moodliar has called for the BCBS to ensure “a fair playing field” for all banks.
Another potential issue with the reforms is that Basel III calculates capital requirements based on “risk-weighted assets”: the riskier an asset is considered, the more of it a bank must hold, to mitigate against this risk in meeting its capital requirement.
However, because many African governments are rated below investment grade and their bonds are therefore seen as a riskier asset, an African bank holding its own country’s sovereign debt may have to hold more capital against it than, for example, a European bank holding French bonds.
Even if the bank itself is strong and well capitalised, its home in the African market may thus make it look riskier in the eyes of the BCBS, pushing up capital requirements and therefore costs.
Already yawning financial gaps
The upcoming implementation of Basel III reforms also comes at a time when Africa is already facing a major financing gap, particularly in economically vital areas such as infrastructure.
According to the African Private Capital Association (AVCA), Africa faces an annual infrastructure financing gap of $100bn for basic needs, expanding to between $181-221bn if the continent is to achieve the United Nations’ sustainable development goals (SDGs). Sub-Saharan Africa currently invests only 3.5% of GDP in infrastructure annually, whereas an estimated 7.1% of GDP is required to meet the SDGs.
Critics fear that the Basel III reforms could make this gap even wider. Sim Tshabalala, CEO of South Africa’s Standard Bank Group, has warned that “Africa needs about $170bn a year in infrastructure investment but is currently only able to raise about $85bn.”
“Basel III rules need to change so that the risk-weighted assets result in banks holding less capital. If banks can hold less capital, they’ll be able to fund more projects.”
However, others have a different assessment. Xolani Sibande, a senior economist at the South African Reserve Bank (SARB) who has researched the implications of Basel III, tells African Business that these issues predate the new regulations.
“African banks have always tended to maintain higher levels of capital than what regulators require because of perceived risk,” Sibande says. “For example, in September, Investec announced it had a CET1 ratio of 14.6% whereas the regulators only required about 8%.”
While not attributing the problem to Basel III, Sibande agrees that more work is required to free up greater amounts of capital for investment in Africa. “I think there is a strong case now that, instead of keeping more capital in-house to cover these minimum capital requirements, more of it could be used to finance SMEs, for example, which would help power growth for African economies,” he argues.
“This is also needed to fund infrastructure, which is needed in almost all African countrie Sibande adds. “Even South Africa, which is a relatively developed country, has huge infrastructure needs – if you look at the standard of roads and the issue of Eskom-related blackouts, that is clearly indicative of deficiencies in infrastructure.”
Whether one attributes the problem to the Basel III regulations or to more long-standing challenges in the African banking sector, it is clear that not enough capital is currently reaching the individuals and companies which need financing to generate the continent’s growth. This is a situation which could inadvertently be exacerbated by global regulators’ attempts to limit the excesses of global banking giants.
Striking a better balance may be easier said than done, however. Sibande says that “to solve issues such as infrastructure and development, which is lacking in Africa, that is where maybe the banks could free up some capital to cover those financing gaps.”
“But then you have to balance that with the risks, and many African economies are very volatile. So, if the banks are not prepared or adequately funded, any slight changes in economic fundamentals may actually spell problems for many of these banks.”