Must-know: The future of banking risks and regulations

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Basel III is currently the best possible regulatory framework

Despite Basel III’s shortcomings, you must remember that it wasn’t the Basel norms that precipitated the subprime or global financial crisis. It was the people who didn’t implement the rules properly.

Basel III is currently the best possible regulatory framework. It’s designed to make banks more resilient. It also incorporates lessons from the 2008 global financial crisis and aims to harmonize banking regulations in an ever more interconnected world.

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Basel III will help banks become stronger. Because of Basel III norms, banks have increased their Tier 1 capital (see chart above). This makes capital base stronger, and as a corollary, banks are better able to withstand external and internal shocks. As we can see in the chart above, the capital situation for U.S. banks is better than European banks.

But there are two sides of a coin to everything. Going ahead into the future, the higher capital requirements imposed by Basel III will lower the return on equity of banks, as more capital will be tied up and unproductive. This is likely to negatively impact a bank’s valuation.

Closing summary

In our previous five-part series on the basics of banking, we’ve learned about the banking sector (read here), the use of price-to-book value ratio and its relation with returns (read here), and the banking risks (read here) and regulations (read here).

We hope that this and previous series have given you a sound footing to understanding the banking sector. So the next time when you’re analyzing any bank—a full-scale bank like JPMorgan (JPM), a traditional bank like Wells Fargo (WFC), an investment bank like Goldman Sachs (GS), a boutique bank like Lazard (LAZ), or a bank that’s part of an ETF like the Financial Select Sector SPDR Fund (XLF)—you’ll be more confident in your analysis.

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