Table of content Introduction Introduction to the subject Problem statement Structure of the Thesis 4

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1 Bachelor Thesis ANR : Name : Roel Bouwens Study Program : International Business Administration Title : Impact of Basel III accord on consumers in Germany Subject coördinator : Morales P. Abstract The research conducted in this papers focusses on the impacts of the Basel III accord, the impact on GDP in particular. The demographic area covered is Germany, because Germany as a country is a good representative for other Western-European countries. Following from this a clear research question can be stated namely: What effect may the Basel III accord have on the GDP of Germany, taking into account banks want to maintain their profitability by increasing their lending spread? In the literature part of this paper the Basel III accord will be explained according to the paper of Hannoun H., (2010). The impact of the Basel III accord on the overall macroeconomy will be discussed by comparing several researches. The empirical research will be conducted on a historical base by comparing the changes in GDP and the changes in the lending spreads to establish the relationship between these two variables. Historical data from the last 15 years will be used on a quarterly basis. The outcomes of this research have confirmed that indeed there is a negative relationship between the implementations of the Basel III accord and the GDP of Germany.

2 Table of content 2 1. Introduction Introduction to the subject Problem statement Structure of the Thesis 4 2. Literature Review Chapter 1: History and content of the Basel III accord : Firm-specific approach of the Basel III accord : system-wide framework of the Basel III accord Chapter 2: Implementation of the Basel III accord Chapter 3: Macroeconomic impacts of the Basel III accord Empirical Research Chapter 4: Impact of Basel III accord on German GDP Conclusion References 25 2

3 1. Introduction 1.1 Introduction to the subject. During the financial crisis, which originated in the banking sector, it became clear the Basel II accord was not sufficient. This accord was published in 2004 and stated capital requirements for banks in order to reduce their risk. The past few years banks took risks which were not calculated by the Basel II accord. This meant a new accord had to be written, which is called the Basel III accord. The starting point of the implementation of the accord is in 2013, banks are allowed to implement the new requirements during a six year period of time with an intermediate state after two years in 2015 (Hannoun H, 2010). This Basel III accord will have several effects on banks profitability, because new and higher capital requirements are stated in the accord. Therefore, banks will implement several changes in their income structure to regain the same level of profitability from a few years ago. 1.2 Problem statement These changes will primarily involve increasing the lending spreads of banks for their customers (Slovik P., Cournéde B., 2011). Increasing a bank s lending spread can be implemented in three different ways, namely increasing the cost of capital, decreasing the costs of funds, or both. Other variables which may affect the lending spreads of banks are the costs and benefits of other assets. These other assets containing the trading books, interbank assets, government bonds and other remaining assets are not taken into account in this research, because the market force establishes the price of these other assets. Therefore it is assumed a bank can not interfere with lending spreads via this way. The macroeconomic impacts of these changes implemented by the banks are substantial. Different measurements can be used to indicate the impact of the Basel III accord on a macroeconomic basis. One of these measurements is the level of the Gross Domestic Product (GDP). The GDP will be affected by the increase in lending spreads. An increase in the costs of capital will negatively affect the investments made by consumers and companies. If the price of investments increase, the amount spent on investments will decrease which again will lead to a lower (increase) Gross domestic Product.

4 This research will be focus on Germany as it has the highest GDP compared to other members of the European Union, according to Eurostat. This is mostly due to the fact that Germany has the highest population of Western-European countries (Eurostat). In the beginning of 2012 France was cut back from an AAA rating to a AA+ rating according to Standard & Poor. Although several of the Eurozone countries had their status affirmed by S&P such as, Germany, Belgium, Estonia, Finland, Ireland, Luxembourg and the Netherlands only Germany and Slovakia have a stable outlook for the future. Therefore, Germany is a good indicator of what affect the Basel III accord will have on the GDP of a healthy country. A sustainable timespan has to be chosen in order to make a valid conclusion. In the long-run the effects of the implementation of the Basel III accord will wear off. The short-run is also not feasible, because the Basel III accord has not been implemented yet. Therefore a conclusion drawn on the medium-run will give the most information on the subject. The Basel III accord implementation starts in 2013 and banks are allowed to achieve the new requirements over six years, which means the accord has the implemented fully in Therefore a timespan of eighteen quarters and thirty-two quarters after implementation have been chosen The research problem in this thesis is: What effect may the Basel III accord have on the GDP of Germany in the medium-run, taking into account banks want to maintain their profitability by increasing their lending spread? 1.3 Structure of the Thesis The research is will be divided into five different chapters. The first three will give information about the Basel III accord, the implementation of the accord and the impacts on the macroeconomy due to the Basel III accord. These are literature reviews based upon different papers. Following up an empirical research will be conducted to establish the relationship between the changes in lending spreads and the changes in GDP in Germany over a specific time span. The last chapter will be used to interpret the results from the research. This research paper will be concluded with an conclusion about the findings. 4

5 The first chapter will introduce the Basel III accord. It will answer important questions like, why a new accord was needed, what is the relationship between the first two accords and the third and what are the new requirements stated by the accord. This chapter is written on a base of the original Basel III accord, but also the paper of Hannoun H. is used frequently. The second chapter explains how banks have to implement the new requirements and how these new requirements will affect the return on equity of the banks. The effects on the ROE is based on a paper published by MCkinsey&Company, namely Basel III and European banking: Its impact, how banks might respond, and the challenges of implementation (2010). The third chapter is mostly based on the research executed by the Macroeconomic Assessment Group, shortly MAG. The MAG was established in order to calculate the impacts of the Basel III accord based on a macroeconomic view. The changes expected in the lending spreads in this research are based upon the calculation formulated by the MAG. In this chapter these calculations are stated and explained what affects they may have on the macroeconomy. In the fourth chapter an empirical research will be conducted on how the changes in the lending spread will affect the GDP for a specific demographical area during a pre-set timespan. Due to the fact that the basel III accord has not yet been implemented fully. This research will conduct hypothesis on historical data. A timespan of 15 years will be set on a quarterly basis. The regression between different interest rates defined as the lending and borrowing rate and the change in GDP of Germany on a quarterly basis will be investigated. The data concerning the interest rates can be found on the German Bundesbank and the data about the GDP can be found on Eurostat a project from the European commission. By looking at the history an prediction can be made on how the Basel III accord will influence the GDP of Germany in the future. To end this research report a conclusion will be presented to summarize the findings of the previous chapters. Also the limitation of the empirical research will be discussed and according to this some suggestions for future research related to this report will be given.

6 2. Literature review 2.1 Chapter 1: Basel III the history and the content of the accord. In 1988 the first Basel accord was published. This accord was established by the Basel committee, who consisted at the time of ten members known as G-10 group. The Basel I accord set various minimum capital requirements for banks. The first Basel accord primarily focused in credit risk. That is, international banks were able to obtain losses without damaging the banking system. The Basel accord achieved this firstly, by ordering banks to cover at least a 4% ratio of their Tier 1 capital (Commonly calculated by subtracting goodwill of equity) to their risk-weighted assets. Secondly, a ratio of 8% between Tier 1 and 2 capital ( Include the most important constituents of a bank s capital base) to their risk-weighted assets (Atkinson,2010). But the world changes and the original Basel accord did not hold up with the financial changes, because of this the Basel II accord was composed by the committee. Basel II was published in 2004 and the purpose of this accord was to set an international standard for banking regulators to control how much capital banks need to reserve to guard themselves against financial and operational risks. It should protect the financial system against different types of problems such as the collapse of a major bank. In essence the second accord intentions were to ensure that a bank has adequate capital for the risk it takes. So the greater risk a bank takes the larger the amount of capital should be to protect itself (Chorafas, D. M. 2004). The Basel II accord described a system which consisted of three pillars. The first pillar dealt with minimum capital requirements, the second pillar set described regulations dealing with supervisory review and the last pillar dealt with the market discipline (Jorion 2006). Some major concerns with the Basel II accord were politically, it was quite difficult to implement the Basel II accord. Because the Basel II accord is not important for this research, it will not be discussed further. The Basel III framework was approved on November 12 th 2010 by the G20 leaders. This framework is set up to prevent another financial crisis from happening, by strengthening the capital rules for banks. Basel III not only became firm-specific, but also industry-specific. This means the accord also provides a system-wide approach(hannoun H. 2010). 6

7 2.1.1 Firm-specific approach of the Basel III accord. Firstly, the firm specific risk-based framework. In the Basel III accord different capital requirements are stated. These capital requirements are all calculated by using the capital equation. The capital equation consist of three elements, namely the numerator, ie capital, the denominator, ie risk-weighted assets and the outcome of the equation. In the old definition of Basel II the term capital was not defined correctly. It was a complex relationship between Tier 1, Tier 2 and Tier 3 capital which made it unclear what capital could be used when a bank made a loss. Due to this mistake global banks did not gave full disclosure to the outside world. Also because several different calculations suited the guidelines of capital stated by Basel II, different outcomes could apply for the same company. Which enabled banks to find a combination which suited them the best. Therefore, The definition of capital has to be clear, because banks risk exposure is guarded by the high quality level of capital. In the Basel III accord the emphasis of the capital definition lays on the common equity capital. Common equity capital has the highest loss-absorbing capacity, therefore it ensures a banks guarding against its risk exposure better. Basel III also states new rules on transparency and the disclosure banks offer to the outside world (Hannoun H. 2010). The next variable in the capital equation are the risk-weighted assets. According to Hannoun H. et. Al. (2010) banks may attempt to understate their risk-weighted assets. Before the credit crisis banks assets showed a solid growth, in contrast with the risk-weighted assets which only showed some minor changes. To overcome this problem the Basel Committee introduced an extra leverage ratio on top of the risk-weighted ratio. This was not the only problem with the calculation of the risk-weighted assets. The risk-weighted calculations in the Basel II accord primarily focused on the banking book, while in the crisis the major losses were due to the trading book. An extra audition to the original risk-weighted calculations is the integration of the trading book. The trading book is now fully integrated in the framework of calculating the risk-weighted assets.

8 The capital requirements are adjusted under the new Basel III accord. Banks need to have a minimum 4,5% of risk-weighted in common equity capital. Furthermore, the Basel committee invented a capital conservation buffer of 2,5%. Which means in times of economic growth, banks need to have a 7% ratio (Basel Committee on banking supervision. 2010). In times of economic recession, banks have to uphold this conservation buffer. To uphold this buffer of 2.5% banks can cut their dividend and bonus payments to their shareholder, employees and other capital providers. This requirement is implemented because during the previous depression, banks still made dividend and bonus payments, which is not acceptable system-wide framework of the Basel III accord To protect the whole market different requirements are stated on a systematic level instead of a firm-based scale. Basel III addresses the problem of underestimating risk-weighted assets by implementing a leverage ratio on top of the original requirements. To avoid procyclicality in the banking market a bank is obligated to obtain an countercyclical credit buffer. In the previous crisis it became clear that some banks were too big to fail, in order to capture this extra risk these banks have extra requirements on top of the original Basel III accord. In the banking market, there exists an interconnectivity due to derivatives between several banks, to assess the problem of this interconnectivity these derivatives are no longer risk-free. The last systemically improvement made by Basel III is to ensure banks engage in stress-test more often due to base several requirements on the outcomes of these stress-tests (Hannoun H. 2010). Banks have to obtain an additional leverage ratio, based on their level of Tier 1 capital expressed in a percentage of its assets, off balance sheet exposures and its derivatives. Tier 1 capital can be defined as a banks core capital consisting of common stock, retained earnings and preferred stock. The reason for this new leverage ratio is to project the changes of a bank s total asset in their risk-weighted assets. The solution presented therefore is that not only risk from the risk-weighted assets is included, but also from a bank s total assets. Which allows on a system-wide level that the taxpayers exposure to bank failures would decrease. According to the state of the economy, banks tend to be procyclicality. Therefore during a weak state of the economy banks tend to amplify the economic crisis and during a strong economic state banks tend to amplify the prosperity. During a economic crisis banks will grant less loans due to the greater risk. A decreasing amount of credit availability will have an amplifying negative 8

9 effect on the economy ( Hannoun H. 2010). To address this problem the Basel III accord requires banks to obtain a countercyclical credit buffer. This buffers ensures the availability of credit during an economic crisis and stimulates investments. The level of this buffers lies between 0 and 2.5% of a bank s total assets depending on an assessment made by each jurisdiction which identifies the level of credit growth in relationship to to measures such as GDP. Some banks in the market are too big to fail, as we have seen in the recent crisis. The past few years several governments have tried to save banks which are too big to fail in the economy of that specific country. The too big to fail principle means that banks, which are to to big and to important for an financial system, can not default. Banks in this position can not default because it is impossible, but because it would have catastrophically impact on the current financial system (Stern, G. H., Feldman, R. J. 2004). This sort of banks are called systemically important financial institutions, SIFI. In order to avoid bailouts by governments Basel III has stated several lossabsorbing requirements for these banks which will be on top of the original Basel III accord. One of the major origins of the global financial crisis in 2009 was the interconnectivity between the banks. The derivatives between banks used to have a zero-risk premium, but the crisis has shown that this is not the case. Therefore banks have to add a risk-premium in the range from 1% to 3% to address the problem of too connected to fail. Before the economic crisis, banks used advanced risk management which are based on the risk models. Value at risk was used to calculate one single risk figure out of several complex risk positions. But the VaR had several shortcomings one of them being that under extreme stress situations the VaR underestimated the risk (Hannoun H. 2010).. To replace the VaR method, Basel III has several requirements based upon regular stress tests. Therefore banks have to engage in stress tests on a more regular basis which should ensure a more reliable risk assessment.

10 2.2 Chapter 2: Implementation of the Basel III accord The implementation of the higher capital ratios will be straight forward for banks. The most important implementation for the research are the changes to the capital requirements which will be divided into to stages. First banks have to increase their common equity capital to risk-weighted assets ratio from 2% to 4,5%. The first stage has to be finalized by the banks in Secondly, the extra conservation buffer of 2,5% has to be added on to those 4,5% by the year of 2019 capital ( Slovik, P. and B. Cournède, 2011). Due to market pressure leading up to the financial crisis, banks in the euro area all ready increased their common equity ratio on average with 1,3 percentage points. Additional to this increase a raise of 1,5 percentage points on average was added to the Tier 1 capital ( Slovik, P. and B. Cournède, 2011). Considering these improvements due to the market pressure, banks need to add 1,2 percentage points to their common equity capital and 0,5 percentage points to their Tier 1 capital on average in order to meet the regulations set for To meet the final capital requirements effective by 2019, banks need to increase their common equity capital with 3,7 percentage points and their Tier 1 capital with 3,0 percentage point on average(härle, Lüders, Pepanides, Pfetsch, Poppensieker, Stegemann, 2010 ). It is assumed that these numbers can be used for Germany, because they are part of the Euro Area. Table 2.1 Increase in capital requirements for banks on average. In the time spans of 2013 till 2015 and from 2015 up and until 2019 Time capital requirements Common Equity Capital Tier 1 Capital ,2% 0,5% ,5% 2,5% As a result of the implementation of the new capital requirements the return of equity of the banks will decline. The new capital requirements require banks to reserve more money, which will have a negative effect on the ROE of a bank. According to Härle P. et. Al. (2010) The effect of the new capital requirements on the ROE will be as followed. Take notice that this is an assessment, it can be that the future will decide otherwise. Not only the capital requirements, but also the funding impacts contribute to the decrease of the ROE. A 0,8 percentage points decline of ROE will be 10

11 accounted for the capital quality. The increased risk-weighted assets will account for 1,3 percentage points as will the the increase in the capital ratios for 1,3 percentage points. The capital ratios will include 0,3 percentage points for the new minimum ratios, The additional buffer will include 0,8 percentage points and 0,2 percentage points for further national discretions. Furthermore will the leverage ratio have a negative effect on the ROE with 0,1 percentage points. The funding impacts will contribute with a decline of 0,8 percentage points of the ROE. The funding impacts can be divided into two divisions. On one hand a 0,2 percentage point will be due to the fact of holding more liquid assets. On the other hand 0,6 percentage points come from the cost of holding more long-term funding(härle, Lüders, Pepanides, Pfetsch, Poppensieker, Stegemann, 2010 ) In this report these findings are assumed to be true.. The new capital requirements will impose on the banks profitability, but because banks want to sustain their levels of profitabilities these costs will be passed on to their customers. One way of passing these costs over to their customers is by increasing their lending spreads. According to Slovik et. Al. (2011) the capital requirements which should be obtained by the banks by the end of 2019 could increase the lending spreads with 50 basis points.

12 2.3 Chapter 3: Macroeconomic impacts of Basel III accord. The implementation of the Basel III accord will have several macroeconomic impacts. A lower leverage with and increase in quantity and quality of capital and liquidity are the consequences. Pressure from market and regulators have already had their influences on the banking system. The Macroeconomic Assessment Group, MAG, composed a report on the macroeconomic impact of the Basel III accord. The MAG consisted of several macroeconomic modeling experts from central banks, regulatory agencies and international institutions. The members of the MAG used models accepted by all, to predict different scenarios concerning time span, capital, and liquidity requirements. One of the problems faced by the MAG was the implication of all the different mechanism in one single model. Unfortunately they were not able to combine monetary policy responses, responses from banks and other market participants and other relevant mechanism into one model. To overcome this problem, the members used several different models and countries. The median is used to combine to outcomes of the different models. The MAG did not include the impact of implementation of several other changes which were stated by the Basel III accord. These were not included because they exceed the prime purpose of the MAG s report, or because it is impossible to phrase scenarios applicable for different geographical areas. Several of these changes are the changes to the definition of capital, deductions from capital and introduction of bank-specific requirements (Macroeconomic Assessment Group, 2010). The data required for the calculations done by the MAG were provided by the International Monetary Fund(IMF). In order to provide accurate outcomes of the models, founded assumptions had to be made about several inputs such as external demand, commodity prices, inflation and exchange rates by the members of the MAG. The IMF provided inputs into the modeling efforts in the different subgroups, drawing on its own work on linkages between the financial system and the macroeconomy, and provided global macroeconomic forecasts that were used by the different national members to make consistent assumptions on important variables such as external demand, commodity prices, energy prices and exchange rates(macroeconomic Assessment Group, 2010).. 12

13 The time span chosen by the MAG was crucial to the research. Outcomes can defer greatly if the deadlines for implementing the Basel III accord changed. Two implementation periods were chosen by the MAG, namely two and four years. Simulations for calculating the effect was set on eighteen quarters and thirty-two quarters. The research calculations assumed the implementation started the first quarter of 2011 and the deadline for achieving the final requirements was set on the fourth quarter of The actual effects on the lending spreads were calculated based on historical date estimated from elasticities. By using an error correction model the relationship was determined via a regression between the lending spreads and the capital requirements on a quarterly base. Because not all members were able to receive the correct data, a second and simpler approach was used for calculating the effects on the lending spreads. This approach assumed, under the current levels loans and liquid assets, rates of returns on those assets and current debt and equity funding costs, that return on equity stayed constant under the Basel III capital requirements. Then it calculated the level of lending spread needed for this. Both these approaches gave roughly the similar results concerning the lending spread. The calculations by the MAG may differ from the actual impact caused by the new capital and liquidity requirements on GDP and bank lending. The actual impacts can be smaller compared to the estimates made by the MAG members. Banks will try ways other than calculating it through to their customers, to overcome the cost of implementing the new requirements. Banks can try to operate in a more efficient manner for example, by reducing the hierarchical levels. Non-loan assets will be replaced by loan assets in order to increase their capital ratios. Secondly, for some strong banks it will not be hard to find some investors who are willing to fund their debt at lower cost and lower required return on equity, because their level of risk does not increase by implementing these new standards. Therefore, these banks might not even need to increase their lending spread, to overcome the cost of the implementation of the Basel III accord. Because there are several ways of financing these new requirement some effects will mitigate away some of the impact on the interest rates. This is the final reason why the actual levels can be smaller than the ones calculated by the MAG.

14 On the other hand you have some impacts which will lead to a greater changes in lending spreads than predicted. Due to a short implementation period of the accord, some banks will have problems obtaining the addition capital which will lead to higher return on equity rates. The demand of liquid assets increases, because of the new standards. Which means the prices of these assets will increase as well. Thirdly, banks which rely on small and medium-sized firms may find it hard to obtain financing. The macroeconomy will be affected by the Basel III accord through the lending spreads. These lending spreads will increase due to the new capital requirements stated in the Basel III accord. Banks will try to meet the new capital requirements via various ways. These ways will make a bank respond adequately by adjusting profitable elements of them. There are different manners in which a bank can increase their capital. Issuing new equity is one of these ways. A second way to increase a banks capital is by increasing its retained earnings, by for example operate more efficiently. Increasing a banks lending spread is another way of raising more capital. Although there are several more ways to achieve this, the last one mentioned is the most important one for this research. According to existing study and opinions of academics and members of the financial sector, banks will use a combination of the three methods mentioned above in order to increase their capital (Macroeconomic Assessment Group. 2010). Which combination of methods and what amount of weight is put on these methods depends partially on the time in which banks are required to achieve these new capital levels. If time is of the essence, increasing their retained earnings might take to long. A much faster way of increasing their capital is to issue new equity, change the composition of their assets and reduce lending. When banks have time enough, they are able to figure out lest costly, but more time consuming methods. More weight will be put on raising capital out of their retained earnings. The MAG s analysis is based on the assumption that banks will raise their lending spread and reduce their loan volumes in order to increase their capital ratios. This is built upon historical evidence. The forecasts made by the MAG are shown in table 3.1 and 3.2. They categorized the changes in lending spread according to the average, minimum and maximum change in lending spread due to an increase of capital requirement of 1%. Furthermore they divided the calculations based upon the implementation time of this 1% capital requirement. The first category is a two year implementation time and the second is a four year implementation time. To give a more accurate outcome the MAG forecasted the changes in lending spreads the first eighteen quarters after implementation and the first thirty-two quarters after the implementation 14

15 Table 3.1 Increase in lending spreads ( in basis points) if capital target increases 1 percentage point over 2 years Range Lending Spreads 18th quarter Lending Spreads 32nd quarter Median 17,3 15,3 Maximum 25,0 25,6 Minimum 5,1 5.1 Table 3.2 Increase in lending spreads ( in basis points) if capital target increases 1 percentage point over 4 years Range Lending Spreads 18th quarter Lending Spreads 32nd quarter Median 15,4 16,1 Maximum 27,8 27,6 Minimum 4,9 5,1 The responses of the banks will have an impact on the economy on a macroeconomic level because of the following four reasons. Increasing the interest rates and tighter lending standards will have a negative effect on the spending of households and businesses. Which means a decline in consumption and investments in the short-run.source (Macroeconomic Assessment Group. 2010). Bank-dependent sectors will more damaged, because of the measurements taken by the banks. Large corporations will figure out other ways to retrieve capital. They are for example able to raise equity. Therefore the group struck by the Basel III accord are households and small and medium sized firms. For this group it is harder to find alternative capital. The third reason focusses on the geographical area of the Basel III accord. If we assume only one country would be obliged to implement the new capital requirements the economic effect would be offset. This because the net exports will increase and the import will decline. In the case of Basel III, the capital requirements have to be implemented in every country. Therefore in every country the domestic spending can slightly decrease. Through the global nature of the accord, these effects could be amplified (Macroeconomic Assessment Group. 2010). The last reason deals with the monetary policy banks will embrace in order to decrease the effects of the new capital requirements (Slovik, P, Cournede, B. 2011).

16 To sum up, banks will most likely increase the interest margins on lending and reduce the amount of lending due capital requirements stated by the Basel III accord. This will only be on the short-term and medium-term. Once banks have achieved these capital ratios, the lending spread will decrease again. Banks are profit firms, they have to compete with each other and in order to compete they will drop their prices, in this case the interest rates, when it is possible. These changes in lending spreads have several implications on the economy on a macroeconomic level, like less spending of households and business, bank-dependent sectors will be more damaged by these measurements, the amplification because of the world-wide implementation and the changes in monetary policies by the banks. 16

17 3. Empirical Research 3.1 Chapter 4: Impact of Basel III accord on German GDP For the empirical research some different information is required. First the historical data about the GDP in Germany is needed. This information can be found on the Eurostat website. I used the GDP of Germany, seasonally adjusted. Seasonally adjusted GDP is necessary to eliminate any increase or decrease in the GDP because of this phenomena. This GDP is based on the prices within germany on a quarterly base and are on average per person. Further more the changes in lending spread over the past years is required. The deposit rates used in this research are drawn from the bundesbank, from 2003 up and until 2011, the MFI interest rates and volumes of German banks is used. These interest rates combined with the interest rates found on Eurostat for the period before 2003 provide the base for the deposit rates. The interest rates on loans are also a combination of the MFI interest rates and the interest rates before hand of the cost of capital to households on a quarterly base. In order to make a valuable conclusion about the calculations made, a clear H0 and H1 should be formulated. By using a clear null and alternative hypothesis, a valuable conclusion can be drawn. By using calculations made in SPSS the null hypothesis can be rejected or not. Verbal hypothesis: Will a change, positive or negative, in the lending spread have effect on the increase or decrease of the GDP in Germany during a time span of 15 years on a quarterly base from 1996 up to and including 2011? H0: A change, positive or negative, in the lending spread has no effect on the change of GDP. H1: A change, positive or negative, in the lending spread has effect on the change of GDP. In this case the change in GDP is the dependent variable and the change in lending spread is the independent variable. Numerous other variables impact the change of GDP, but because this research focuses only on the effect of Basel III on GDP by means of the lending spread these moderators are only used as control variables. Several control variables have been added to the research. To start with the total population of Germany. The total population effects the GDP through the means of the work force. If the population increases the number of people being able to work will increase as well and therefore the total GDP will grow. The total population on an yearly

18 basis can be found on Eurostat. In this research it is assumed that throughout the year the population grows or declines in a steady way. The unemployment rates are also related to the changes in GDP. When the unemployment rates for a specific country increases, the number of people contributing to the GDP will decrease. Therefore, the unemployment rate has a negative effect on the GDP. The unemployment rates used in this research are gathered from Eurostat. The unemployment rates are the seasonally adjusted, total population and all ages unemployment rates of Germany. The total amount of the workforce which is employed has a positive effect on the GDP, because an increase in employed workforce means more people are producing which increases the GDP. Therefore, the employment rates are used as a control variable. In this research the employment rates based upon an age between 15-64, total population, both sexes and geographic area Germany are used. These rates can be found on Eurostat, from 1999 to 2011 on a quarterly basis, and from 1996 to 1998 on a yearly basis. To overcome this problem, it is assumed that in these three years the employments grows or declines on a steady line. The last control variable used is the inflation. The GDP can be calculated on base of all products/services sold in a country. If prices increases, inflation, then the GDP of a country will increase as well. The inflation data used in this research is based upon the date from Homefinance, a company based in Utrecht, The Netherlands. The inflation is expressed in an index called the consumer price index, which is a measurement to indicate the inflation. 18

19 Table 4.1 descriptive statistics about the variables used. Variable N Minimum Maximum Mean Std. Dev Percentile change in GDP Percentile change in Lending Spreads Percentile Change in level of Population Germany Percentile change in level of Unemploym ent Percentile change in level of Employment Inflation Germany 84-4,000 1,90 0,3214 0, ,26 14,80 0,5222 3, ,7 0,22 0,0310 0, ,49 5,56 0,1145 3, ,28 1,56 0,1264 0, ,31 2,71 0,5131 0,49839 In this research it is assumed that there is a relationship between the increase or decrease in lending spreads and the change in GDP. This assumption can be made, because several other academical papers, like the report published by the MAG, use the GDP the express the impact of the lending spreads. As in table 4.2 is shown, the significance level of the percentage change in lending spreads on the change in GDP is 0,001. Which means the model of the dependent variable, percentile change in GDP, independent variable, percentile change in lending spread, and the control variables stated above is significant correct. This means the model can be used to determine the relationship between the dependent and independent variable. Therefore H0 can be rejected and H1 can be accepted, a change, positive or negative, in the lending spread has effect on the change of GDP.

20 Table 4.2 ANOVA Model Sum of Squares df Mean Square F Sig Regression 14, ,813 4,995 0,001b Residual 40, ,563 Total 54, In order to establish the regression line between the dependent variable, percentile change in GDP, and the independent variable, percentile change in lending spreads, a regression analysis is executed. The results of this analysis can be seen in table 4.3, again the same variables are used as the control variables. These control variables make sure the significance of the model is 0,001. Table 4.3 Coefficients Dependent variable: Percentile change in GDP of Germany Model B Std. Error Constant 0,342 0,126 Inflation Germany 0,156 0,197 Percentile change in level of Employment Percentile change in level of Population Germany Percentile change in level of Unemployment Germany Percentile change in Lending Spreads -0,104 0,113-0,462 1,572 0,15 0,038-0,130 0,028 20

21 In order to predict the decline in GDP caused by the increase in lending spread, a regression equation has to be made. A standard regression equation look like: f ( x ) = r * x + B In this equation x is the variable which has to be filled in. This will be the changes in lending spreads due to the Basel III accord given by the MAG report. The slope of the equation is stated by r, and from table 4.3 can be concluded that r = - 0,130. The intercept, B, is a constant number 0,342 given by the table 4.3. This leads to the following regression equation: f ( x ) = - 0,130 * x + 0,342 To calculate the full impact of the new capital requirements stated by the Basel III accord on the GDP of Germany, the information stated in table 3.1, 3.2 and the information stated in table 2.1 have to be combined and used on the new regression equation. The requirements due for 2015 indicate a two year time period for requiring the new capital. According to table 2.1 a total of 1,7% capital has to be raised on average by banks by Combine this with the changes in lending spreads according to the table 3.1. This means the lending spreads will increase 1,7 times as much as stated in table 3.1, which can be seen in table 4.4. Table 4.4 Increase in lending spreads ( basis points ) if target capital increases 1.7 percentage points in two years. Range Lending Spreads 18th Quarter Lending Spreads 32nd Quarter Median 29,41 26,01 Maximum 42,5 43,52 Minimum 8,67 8,67 On top of the requirements of 2015, banks have to meet another set of capital requirements up and until Which are an extra four years to reach these new capital targets. In these four years banks have to increase on average their capital with 5% according to table 2.1. The effect these new capital requirement have on the lending spreads of banks can be seen in table 4.5. In this table the change in lending spread due to a increase in capital target of 1% over a period of four years is multiplied with the new capital targets required by the Basel III accord.

22 Table 4.5 Increase in lending spreads ( basis points ) if target capital increases 5 percentage points in four years. Range Lending Spreads 18th Quarter Lending Spreads 32nd Quarter Median 77 80,5 Maximum Minimum 12 20,5 With these changes in lending spreads due to the new regulations, the impact on the GDP in Germany can be determined. To calculate this impact the changes in lending spread have to be plugged in to the regression formula. The impact of the new capital requirements effective by 2015 can be seen in table 4.6. On top of these changes in GDP, the effects of the 2019 requirements have to be calculated, there results are shown in table 4.7. Table 4.6 Changes in GDP ( Basis points ), in an 18 and 32 quarter timespan, based upon the changes in lending spreads caused by the requirements effective by 2015 Range GDP 18th Quarter GDP 32 Quarter Median ,0393 Maximum -5, Minimum -0,7851-0,7851 Table 4.6 Changes in GDP ( Basis points ), in an 18 and 32 quarter timespan, based upon the changes in lending spreads caused by the requirements effective by Range GDP in 18th Quarter GDP in 32nd Quarter Median -9,668-10,123 Maximum -17,728-17,598 Minimum -1,218-2,323 In table 4.6 and 4.7 the effects of the Basel III accord on the GDP in Germany are shown. This forecast is based on historical data from the dependent, independent and control variables, and on the predictions made by the MAG of the effects of the Basel III accord on the lending spreads. 22

23 The implementation of the first period, from 2013 until 2015, will have an average negative effect on the German GDP of -3,8233 basis points on an 18 quarter timespan and a -3,0393 basis points effect on a 32 quarter timespan. The second stage of the Basel III accord, from 2015 up and until 2019, will have a average negative effect on the German GDP in basis points of -9,668 on an 18 quarter timespan and a -10,123 on a 32 quarter timespan.

24 4. Conclusion The renewed Basel accord, named Basel III, will be implemented the upcoming year. Not only will this accord affect Banks, but through a series of actions the implementation will impact the whole macroeconomic system. The Basel committee starts these series of actions by publishing the new Basel III accord, which is built on top of the old Basel II accord. The most mentionable changes in the new accord are the new definition of capital, the integration of the trading book in the riskweighted assets, the increased capital requirements and new leverage ratio, the countercyclical credit buffer, extra safeguard against the so-called too big to fail and too connected to fail banks and as last the increased amount of stress-testing. From 2013 on banks all over the world have to implement these new rules, which will have an impact on their return of equity, especially the new capital requirements will contribute to this. Up to 2015 banks have to increase their capital reserves with 1.7% and from 2015 up and until 2019 with 5%. To overcome these extra costs and decline in ROE, banks will increase their lending spreads. This way they pass of the the Basel III requirements to the public. The Macroeconomic Assessment Group calculated the impacts of the Basel III accord on the lending spreads and came up with an average increase of the lending spreads of 17,3 basis points on an 18 quarter timespan after implementation and 15,3 basis points on a 32 quarter timespan after implementation, under the condition the capital target of 1% had to be reached within two years. If the capital target of 1% had to be reached within 4 years the increase in lending spread on an 18 and 32 quarter timespan would have respectively been 15,4 basis points and 16,1 basis points. These increases in lending spread will have a negative impact on the quarterly GDP of Germany. The first implementation period of two years will have an average negative effect on the GDP by -3,8233 basis points on an 18 quarter timespan and basis points on a 32 quarter timespan. The second, four year, implementation period will have a negative effect on the GDP on average by -9,668 basis points on an 18 quarter timespan and -10,123 basis points on an 32 quarter timespan. As hoped the research complies with the negative relationship stated in the introduction between the implications of the Basel III accord and the economical impacts for Germany. This research is all done on assumptions and forecasts made by several different groups and academics which means the forecasts concluded in this research can be incorrect. Furthermore, the basis for the forecasts lies within historical data, which is not able to predict the future. Therefore this research should only be used as an assumption not as an given fact. 24

25 5. References [1] Altman, E. I., Sabato, G. ( 2005 ). Effects of the new basel capital accord on bank capital requirements for SME s. Journal of Financial Services Research, 28, 1-3, [2] Aragon, G. O., Strahan, P. E. (2012). Hedge funds as liquidity providers: Evidence from the Lehman bankruptcy. Journal of Financial Economics, 103, 3, [3] Basel Committee on Banking Supervision. (2010). Basel III: A global regulatory framework for more resilient banks and banking systems. [4] Blundell-Wignall, A., Atkinson, P., (2010). Thinking beyond Basel III: necessary solutions for capital and liquidity. Journal: Financial Market Trends. Issue 1. [5] Chorafas, D. M. (2004). basel II, Impacts and cost of implementation [6] Deutsche bundesbank (2010). The performance of German Credit Institutions. [7] Dwyer, G. P., Lothian, J.R. (2012). International and historical dimensions of the financial crisis of 2007 and Journal of international money and finance, 31, 1, 1-9 [8] Goodman, A. C., Thibodeau, T. G. (2008). Where are the speculative bubbles in US housing markets? Journal of Housing Economics, 17, 2, [9] Hannoun, H., (2010) The Basel III Capital Framework: a decisive breakthrough. Bank for international settlements. [10] Härle, P., Lüders, E., Pepanides, T., Pfetsch, S., Poppensieker, T., Stegemann, U., (2010). Basel III and European Banking: Its Impact, how banks might respond, and the challenges of implementation. Mckinsey Working Papers on Risk, 26. [11] Jorion, P,. (2006) Value at Risk: The New Benchmark for Managing Financial Risk, 3rd Edition. [12] Macroeconomic Assessment Group, ( 2010 ) Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements.

26 [13] Slovik, P, Cournede, B. (2011). Macroeconomic Impacts of basel III. [14] Stern, G. H., Feldman, R. J. (2004). Too Big to Fail: The Hazards of Bank Bailouts. 26