Analytical Note VI. Basel III1
1. Guatemala is well placed to gradually implement key components of the Basel III accord. It is in compliance with most of the Basel I framework, has made good progress in applying the Basel Core Principles, and leads the region in the implementation of consolidated supervision. Despite recent progress, risk-based supervision is still to be fully implemented, in line with other countries in the region.
2. Introducing Basel III standards would increase bank soundness and strengthen financial stability, but could weigh on economic growth in the short term. The Basel accord has evolved to address weaknesses uncovered by the 2008-09 global crisis, mainly by strengthening capital and liquidity requirements. However, banks faced with higher capital and liquidity requirements may be forced to curtail credit supply and adjust asset composition, which could have an adverse impact on output in the short term.
Adjusted vs. Unadjusted RWA and Common Equity
Sources: Supervisory Authorities and Fund staff estimates.
3. When adjusted by Basel III guidelines, the capital adequacy ratios of Guatemala’s banking system decline due to adjustments in risk-weighted assets (RWA) and capital. The adjustments to RWA to meet Basel III requirements for Guatemala’s banking sector are estimated at 28.5 percent. The size of the adjustment is close to the region’s average. Common equity is reduced by 6.3 percent when applying Basel III criteria, which is above most countries in the region. Therefore, Guatemala’s banking system will fall short of Basel III Tier 1 and total capital ratios when applying the previous criteria. Moreover, current capital levels would not suffice, on average, in case supervisory authorities were to implement a countercyclical buffer of up to 2.5 percent of RWA (also in line with Basel III standards).
CAPDR - Estimated Basel III Capital Gap
Sources: Supervisory authorities and Fund staff estimates
4. Guatemala’s banking system exceeds Basel III minimum liquidity requirements. This holds even after adjusting for the liquidity coverage ratio and net stable funding ratio methodologies. Short-term liquidity is more than twice the Basel requirements, while long-term liquidity is at 130 percent of the requirement.
5. The macroeconomic impact of the transition to Basel III total capital requirements is fairly low. The impact of the new Basel III capital requirement on short-term output growth in Guatemala was estimated using a Vector Auto Regression (VAR) model. The results suggest that the at-peak growth impact of increasing total capital ratio by 1 percentage point would amount to about -0.03 percentage points of GDP, and that growth returns to the steady state after approximately 50 quarters from the beginning of the total capital ratio increase, in line with the region. Such growth impact is in the low range of values for the macroeconomic impact of the transition to stronger capital and liquidity requirements for BIS countries compiled by the BIS Macroeconomic Analysis Group. Taking into account the negative gap vis-à-vis Basel III capital requirements, the macroeconomic impact of bringing total capital up to minimum Basel III requirements would have an at-peak impact of about -0.02 percentage points of GDP in Guatemala.
6. Guatemala would benefit from using Basel III as a guide to strengthen prudential regulation and supervision. The Basel III framework would be appropriate given the growing size and complexity of Guatemala’s financial system. Basel III implementation would help improve supervisory skills and regulatory and risk management frameworks.
7. The pragmatic approach that Guatemala has followed in the implementation of Basel standards should continue guiding the implementation of Basel III. It is more appropriate to focus on those elements of Basel III that are more relevant for Guatemala’s financial markets. The elements with the highest short-term priority should be: (i) adopting Basel III definitions of capital; (ii) implementing a capital conservation buffer; and (iii) introducing a leverage ratio. Over the medium-term, the priority should shift to: (iv) aligning liquidity requirements with Basel III; and (v) strengthening the supervisory process (Pillar II) and market discipline and transparency (Pillar III). In the long term, other elements might become important, such as: (vi) considering macroprudential instruments; and (vii) implementing capital charges for systemically important financial institutions.
8. Legal and industry-based challenges to implementing Basel III in Guatemala seem manageable. Implementing most Basel III elements require regulations that fall largely under the purview of Guatemala’s supervisory authorities. At the industry level, the weak presence of large international financial groups might represent a challenge to adopt best international standards and Basel III compliance in the short term.
Prepared by Fernando Delgado and Mynor Meza.