If the Basel III regulations had been in effect over the past four years banks would have experienced sizable inflation in their regulatory capital by recording unrealized gains and losses, according to a new report from Charlottesville, Va.-based SNL Financial.
The implementation of the Basel III rules are currently delayed, in large part due to opposition from the financial services industry. Banks mounted fierce opposition to the new "liquidity coverage ratio," which they argued would lead them to dramatically cut back lending. Banks also wanted a broader array of assets to count as “high-quality liquid assets.”
Banks also opposed the inclusion of unrealized gains and losses in regulatory capital required by Basel III. This would occur since the rules in their current form provide for accumulated other comprehensive income (AOCI), which captures unrealized gains and losses of banks' available-for-sale securities, to flow through regulatory capital, said SNL.
According to the report, if those rules go in force as they exist today, many believe that banks will simply have to hold more capital against their securities portfolios to prepare for volatility. Critics of the rule also said the removal of the AOCI filter would reduce institutions' flexibility to manage liquidity and would diminish the overall level of liquidity in the debt markets.
According to SNL, these fears may be warranted. The research firm said its data shows that capital ratios would have risen notably if unrealized gains and losses had flowed through regulatory capital in recent periods. SNL reported that the median of commercial banks' unrealized gains at the end of the fourth quarter equated to 2.41 percent of the institution's Tier 1 capital, compared to 2.40 percent a year earlier. That means that if Basel III had been implemented in the fourth quarter, commercial banks would have seen their regulatory capital ratio increase by close to 2.4 percent, assuming all other things equal, the firm said.