A group of financial regulators have agreed on a deal to dramatically increase the cash reserves held by banks around the world.
The deal, struck yesterday in Basle, will see banks having to hold more than double the current level of common equity and retained earnings as cash.
These new rules will be phased in between 2015 and 2018, seeing the current minimum for this core Tier 1 capital increased in stages from 2% to 7%.
Doing this should result in a number of things.
It should mean that banks have a better ability in the future to absorb losses without resorting to bail outs from the taxpayer. Holding more of their reserves as readily accessible cash means they can call on this more easily in the event of difficult financial conditions.
Banks will be penalised if their core Tier 1 capital ratios fall below 7%. If this happens in the future, it will prevent them from paying dividends to shareholders and bonuses to staff.
An unfortunate consequence of this move could be to limit lending in the future. If banks need to hold onto more of their reserves as cash, they are likely to become more selective about where they lend money and where they utilise capital within their businesses.
In fact, it could result in a move away from retail banking activities to more profitable investment banking.
Whilst the G20 group of nations still need to ratify this agreement at their summit in November, and then individual nations will need to enact laws to bring the agreement into force, a move towards higher cash reserves for banks looks inevitable.
It will be interesting to see how markets react to this announcement both in the short and longer terms. It will also be interesting to see what strategies the individual banks come up with to avoid this deal having too much of an impact on their ability to generate profits.
