Published in the Financial Times
Tuesday, September 20, 2011
Global regulatory efforts to make banks safer and more responsible could drive up the price of some basic transaction services, bankers and consultants have warned. These include payments processing and securities custody.
Some institutions may quit those businesses entirely.
The Basel III reform package agreed by international regulators last year requires banks to hold more and better quality capital in case of losses. It also includes the first international liquidity rules that will oblige groups to hold enough cash and easy-to-sell assets to survive a 30-day market crisis. US and European regulators are also enacting local regulations that will raise costs and could hit profits.
The reforms weigh hardest on the riskiest endeavours of the banking industry: proprietary trading (on a bank’s own account, rather than for customers) and securitisation (packaging and reselling debt). However, even plain vanilla fee-for-service business lines may feel the pinch. David Sayer, global head of retail banking at KPMG, says that higher costs will change the commercial reality of transaction banking, in part because of additional regulatory requirements. “The challenge in a competitive market will be to pass those costs on to customers.”
Payment services is a particular area of concern, because it is relatively low-margin and requires a lot of intraday liquidity. This has become far more important and expensive because of the Basel III requirements. Banks will either have to charge more for payments processing and see their profits shrink, or turn to outside providers and save their liquid assets for other businesses.
Paul Styles of ACI Worldwide, a payments software provider, says: “You could see a number of banks pulling out of the payments business because it is just too expensive. It’s still early days. This is a general concern for banks.
“Whether that concern will escalate sufficiently for banks to pull out of payment services entirely is not clear. The potential is there.”
But Mark Garvin, chairman of JPMorgan’s international treasury and securities services business, is optimistic that regulators will make changes where needed. Global regulators are collecting information on liquidity stocks as part of an observational period before the rules take effect in 2015. “The observation period is long enough to allow policymakers to assess the impact and adjust as necessary,” he says.
Also, the profitability of custodial services could be threatened by rules designed to prevent a repeat of the Bernard Madoff fraud scheme. In that scandal, banks such as UBS and HSBC were hired to serve as custodians for funds that sent money to Mr Madoff, but they delegated their responsibility to safeguard assets back to Mr Madoff. When he turned out to be a fraud, the fund clients filed suit both in the US and in Europe. The EU’s new directive for alternative investment managers increases the legal onus on custodians by holding them more responsible for their subcontractors.
Trade finance businesses could also be at risk, under the current version of the Basel III capital rules. These effectively increase capital requirements fivefold by assigning trade lending the same risk weight as other corporate lending. Banks have been arguing that the higher risk-weight makes no sense, given the short-term nature of the loans and the history of low loss rates. Many of them are now optimistic the capital rules will be eased, but regulators have not publicly said this will happen.
Even if the rules for wider transaction services are eased, banks may find their ability to make profits in this area constrained. That is because they tend to be businesses that require frequent upgrades to systems and security. Many banks will have less to invest, because they will need to retain profits to build up capital to meet the Basel III requirements for their other businesses. “The transaction business is not a balance-sheet heavy business, but it needs technology and constant investment. Some banks that have to raise capital [because of Basel III] will be tempted to reduce the pace of investment and some may choose to make a strategic decision to focus elsewhere,” says Mr Garvin.