On 7 December last year, agreement was reached on the remaining proposals on bank capital requirements from the Basel Committee, thereby completing the main body of the post-crisis regulatory reforms. While they remain to be implemented, we are now clearly rebalancing away from rule making towards evaluating the effectiveness of the reforms.

It is generally acknowledged that that adoption of the Basel rules has made both banks and the overall financial system more resilient. A new post crisis regulatory framework was needed and has been broadly supported by the industry. However, there is not much empirical research available on the actual costs and benefits of the reforms. Instead, policymakers have been forced to rely on forward-looking studies which provide best guesses of what the impacts were likely to be in the future.

Nevertheless, the main body of the post-crisis reforms has already been influencing banks’ strategic decision-making, particularly in relation to their capital markets activities. So now is the right time to assess how these reforms have actually influenced banks’ activities in this area. AFME therefore commissioned PwC to conduct an ex post study to examine the role of regulation in the shrinkage of capital markets products. The study draws on data up to 2016 across 13 global banks covering approximately 70% of global capital markets activity.

Among the findings was the cost of regulation for capital markets activities was around US$37bn or nearly 40% of total capital markets expenses in 2016. The biggest regulatory impacts have resulted from capital and leverage, but further material effects are likely once the effects of MifIDII/MiFIR are known and the full suite of Basel proposals have been fully implemented.

Even before the implementation of these proposals, regulation has helped drive a sharp decline in bank profitability. For example, RoE fell from 17% to 3% between 2010 and 2016 (before banks’ mitigating actions through cost reductions, repricing and capital reallocations raised underlying returns to 11%).

Higher regulatory costs and lower returns have also been a significant driver of a 39% decline in capital markets assets since the crisis with particularly pronounced declines in rates, credit, commodities and equities. PwC’s analysis showed that regulatory impacts were by far the biggest factor behind this fall, accounting for around two thirds of the net decline in capital markets assets.

Other non-regulatory factors, such as low profitability, economic growth and monetary policy, while not as significant, were nevertheless still important in banks scaling back their activity. With both the implementation of outstanding regulations and other competitive challenges foreseen, asset shrinkage is likely to continue, and profits can be expected to remain under pressure.

It is positive therefore that the Basel Committee is revisiting the calibration of certain aspects of its market risk capital proposals and has postponed their implementation until the beginning of 2022.   It also encouraging to see the willingness of the Committee and the Financial Stability Board to review the overall effects of the post-crisis framework, alongside the impacts of particular rules on the functioning of specific markets, a process that has already begun. Similar welcome initiatives are in train in Europe and the US to better align regulation so that it more accurately balances the requirement for a resilient financial system with the need to support markets and their users, as well as economic growth. 

However, these initiatives need to be a shared endeavour in which the industry plays a full part in assisting policymakers to gain a complete understanding of the impacts that regulation has had on business models and market functioning. Only in this way can we together create a better, and ultimately safer, banking system.

You can read the full study here