WASHINGTON — After years of concerns that the Basel II accord would lead to drastic capital drops, a study has found that the largest domestic banks may find themselves hoarding more capital instead, as a result of the liquidity crunch.
The study, released last week and conducted by Federal Financial Analytics Inc., indicated that in a matter of months problems in the credit markets have silenced nearly a decade of worries that Basel II would let banks hold significantly less capital against risks.
The end result, according to one of the study's authors, could be a further tightening of credit.
Bank assets have "become a good deal riskier than the initial quantitative impact surveys, or, for that matter, internal models, had anticipated, so the risk-based capital requirements will spike sharply upward, and that will have an overall impact on credit availability, although lower-risk credit would be favored and might not be as adversely affected as higher-risk obligations," said Karen Shaw Petrou, the managing director of Federal Financial Analytics.
The study highlighted the perils of implementing Basel II as the mortgage market weakens under the weight of subprime loans. Regulators and the 12 largest domestic banks are preparing to implement Basel II on a trial basis early next year before abandoning the current capital regime entirely in 2009.
But Ms. Petrou said the pain bankers likely would feel does not take away from the benefits Basel II would provide.
"It vindicates Basel II," she said. Under the current Basel framework, "you had all this regulatory capital arbitrage … which led people to exactly what we've seen in mortgages."
The study did not say how much capital requirements might increase, but it noted that even without the market problems, Basel II likely would require higher capital holdings against equity holdings and exposures to the government-sponsored enterprises.
Factor in the problems in the credit markets, and the study found that the timing of Basel II's implementation likely would add even more pressure to bankers' bottom line.
"As Basel II begins under market conditions not factored into its specific capital provisions or even the stress testing to be required by supervisors, its capital costs could compound with implementation ones to have significant product and profitability implications," the study said.
