While its not hot in the mainstream media, there's been a great deal of talk lately in financial circles about Basel III. There's a great review of the what Basel III is over at BankSimple, but the gist of the changes to the world's banks is this:
- Banks are required to carry capital of at least 7% of risk-weighted assets
- Banks are required to carry capital of at least 3% of all assets
- Banks are required to carry sufficient liquid assets to cover 30 days of liabilities The question I have is, so what? Credit Unions in this country have been doing that and better for years.
I've been involved in credit unions for years now. Mostly I do it because of their commitment to community and if you're from a small town like I am, you'll know how important that is. But there are many very good financial reasons to get involved to. Learning from the best is part of why I sat on the Board of Directors for Servus Credit Union. But back to Basel III.
If you look at the credit union act in your province, you're going to find that it takes each one of these statements and one-ups it. Lets look at each in turn.
Capital % of assets
So what does Capital mean anyway? Well, capital is basically the difference between what a bank owes and what it owns. Banks are a bit tricky, though, because they look at things backwards to you and me. To you, when you deposit money in the bank, that money is an asset. Its money you have for later. To a bank, that same deposit is a liability and it goes squarely against its liabilities, what it owes. Money you owe the bank, like your mortgage, to you, is a liability. Money you have to payback every month. To a bank, that's an asset. The mortgage value and the interest it will accrue are booked as assets, what it owns. In theory, the assets are there to assure lenders (the people that have given the bank money, including you with your savings account), that if things go south, they can liquidate assets and cover their debts. The difficulty with banks is that they typically need to keep a bunch of cash around (deposited by you and therefore a liability) to cover off the mandatory capital requirements. When you pair that with investors who'd like to see those assets liquidated in order to produce dividends, captital requirements are not popular. And that is what got them in trouble in the first place.
Basel III mandates that banks hold (by 2019) 7% of their Risk-weighted assets and 3% of total assets as captital at all times. Risk-weighted refers to those assets which carry a certain degree of risk of default or of non-liquidity and consequently the requirements are higher as they may not actually be convertible to cash in a time of need. Those seem like pretty resonable numbers, don't they?
So how about your local credit union? Well, in Alberta at any rate (and most other provinces are similar, or identical), the capital requirements are:
- 4% of total assets; and
- 8% of risk weighted assets a full point ahead of even the newest, most conservative measures in place for banks and they've been that way for years. On top of that many of the credit unions, such as Servus hold capital in the range of 8.5% of total assets and 12.5% of RWAs.
And then there's liquidity, the ability of a Bank to pay its liabilities without going to the market to sell any of its assets. Basel III has the provision that banks have enough cash/liquid assets on hand to be able to repay 30 days of its liabilities at all times. In big banks, that's a lot of cash. But that's like saying that you are expected to have cash on hand to be able to pay all of your monthly bills. While not all of us are that disciplined, its not a strech to conceive of being able to manage that, so why should we not expect our Banks to be able to pay their bills either?
Now, as I understand it with the credit unions, there's probably going to need to be a change too. Carrying a 100% of a months net cash outflows is a serious endeavor. But at least they had a liquidity ratio requirement in Act:
- Under the Credit Union Act of Alberta the Credit Union is required to maintain a liquidity ratio of
9% of two months prior average monthly liabilities.
9% of the last 2 months is a heck of lot more than nothing, which was basically what the banks were relying on before.
There's also a little thing about guarantee. If you read into the liquidity and more importantly the capital requirements, you'll quickly realize that if everything went south, even with the high levels of capital held by credit unions, there wouldn't be enough money to cover the total liabilities the bank holds. So if everything went south, would you get your money back?
Well, in the banks, if you had less than $100,000 deposited, yes. That's what the Canada Deposit Insurance Corporation assures you of. And the credit unions? Well, the Deposit Guarantee Corporation provides assurance of 100%, with no maximums. So even if your credit union folded, you'd get every last penny back. So protections of Basel III aside, which would you rather?
I'm not sure what all the hubub is about, really, but I guess its just an indicator of how bad things were before that this is heralded as the next best thing to sliced bread. Be glad, I suppose, that the world is waking up and enforcing a certain degree of accountability on the banks. But then go put your money in your local credit union.