The Basel III Endgame: A New Era for Non-Banks in the Financial Sector

March 11, 2024

Terry Hollingsworth, Global Head of Futures Clearing Sales, Marex


The financial landscape is undergoing a significant transformation, driven by regulatory reforms and evolving market dynamics. One substantial driver is banks re assessing their risk appetite and deploying capital to less balance sheet heavy activity and is indicative of a broader trend within the banking sector.

This trend is largely driven by the Basel III endgame, a series of regulatory reforms aimed to enhance the strength and resilience of the global banking system. These reforms predominantly impact banks with over $100 billion in assets, and will lead to an estimated 16% increase in Common Equity Tier 1 (CET1) capital levels and a 20% increase in Risk-Weighted Assets (RWA) for large bank-holding companies.

The impact of Basel III is particularly acute for banks with large fee-based businesses, as highlighted by the FIA in its letter to the Board of Governors of the Federal Reserve System:

“A quantitative impact study of our member firms shows that the two Proposals would collectively increase the capital required to engage in client clearing activities by more than 80 percent, and the Endgame Proposal would, on its own, increase the capital required to engage in client clearing activities by more than 22 percent.”

Opposition and Lobbying

Banks, congressional Republicans, and various interest groups such as small businesses, multinational corporations, and the real estate sector have strongly opposed the proposed rule change. They present several arguments, but mainly contend that the rule is excessive and would compel banks to reduce their lending activities.

Daniel Pinto, JPMorgan Chase’s president and chief operating officer, cautioned that the heightened capital requirements for US banks could significantly affect market liquidity and lending capabilities. At the Financial Times Global Banking Summit in November, Pinto noted that the proposed implementation of Basel III would primarily influence the lending and markets operations of the bank.

Meanwhile Jamie Dimon, CEO of JPMorgan testified before the US Senate Committee on Banking, Housing, and Urban Affairs on December 6 and argued that the proposed Basel III Endgame Rule would unnecessarily increase capital requirements by 20-25% for the largest banks. Therefore, they will either stop offering certain products and services or charge more for them.

Just before the end of 2023, it was reported that Citi decided to shutter its municipal bond business. It was part of its strategic review, but many observers noted that the move came ahead of the GSIB deadline.

Opportunity for Non-Banks to Increase Market Share in Financing-Heavy Activities

As major banks adjust to increased capital requirements, a new opportunity arises for non-banks to play a more significant role in the industry. As Rupak Ghose notes in IFR, prime brokerage revenues at investment banks have doubled over the past decade to around US$30bn, but this fee pool is set to come under increased competition from those players who do not have similar RWA requirements.

Most notably there is an evident growth in balance-sheet heavy activities such as prime services, in non-banks. Capitalising on the space vacated by larger banks, they offer specialized services that cater to a diverse client base. Non-bank financial institutions can compete against large GSIBs by leveraging certain strategic advantages and opportunities that have emerged in the market:

Capitalising on Big Banks’ Strategy Shifts: Large banks are increasingly focusing their prime brokerage services on their most lucrative clients, often sidelining smaller hedge funds, family offices, and RIAs. This creates an opportunity for non-bank providers to fill the gap by offering services to these underserved segments.

Investing in Modern Technology: One of the key differentiators for non-bank prime brokers is the investment in modern technology, particularly cloud-native systems. This technology provides more efficient and agile services compared to the legacy systems used by many large banks.

Specialised Services: Non-bank providers can offer more tailored and specialized services compared to the one-size-fits-all approach of large banks. By focusing on niche areas and specific client needs, they can create a competitive edge.

Client-Centric Approach: Non-bank financial institutions can distinguish themselves by offering a high level of client service, understanding and addressing the unique pain points of their clients. This client-centric approach is especially appealing to smaller funds and emerging managers.

Flexibility and Agility: Non-banks are often more agile and can adapt more quickly to changing market conditions and client needs. This flexibility allows them to innovate and offer solutions that might not be feasible for larger, more bureaucratic institutions.

In this evolving landscape, non-banks emerge as key players. Not subject to Basel III capital requirements, non-banks can step in to offer services that banks might scale back. This positions them to maintain the efficiency and stability of various financial markets, including derivatives.

Embracing Change in the Financial Sector

The key for non-banks is to identify and offer alternatives to large GSIBs, by focusing on areas where they can provide superior value or service. As the financial landscape evolves, particularly with technological advancements and changing client needs, non-bank service providers have significant opportunities to establish themselves as competitive alternatives to traditional large banking institutions.

The Basel III endgame is more than a regulatory shift; it’s a catalyst for broad-spectrum implications across the financial services industry. This period gives non-banks a chance to showcase their capabilities in a transforming market, providing essential services that meet the evolving needs of the sector. For clients, the entrance of non-banks offers a potential for an enhanced, more nimble service. Moreover, the healthy competition between non-banks ensures clients benefit from a better service and more favourable pricing. As the industry adapts to the Basel III regulations, the adaptability and innovation of non-banks will be key to maintaining a dynamic and resilient financial ecosystem.

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