The Impact of Basel III Indexes of Leverage and Liquidity CRDIV/CRR on Bank Performance: Evidence from Greek Banks

Abstract

The recent global financial crisis (GFC) of 2007-2008 revealed several critical shortcomings
in the existing Basel II international banking supervisory framework. The Basel Committee
adopted a set of reform measures inclusive of additional solvency and liquidity rules, known
as "Basel III". Through a new Directive and Regulation known as the CRD IV and CRR
package, the European Union implemented Basel III in January 2014. We investigate the
effects of the new liquidity and leverage requirements (CRDIV/CRR) under Basel III on the
performance of Greek banks for the period 2004 to 2013 which includes both the GFC and
the Sovereign Debt Crisis in Europe. We find that the leverage ratio shows a statistically
significant albeit positive association with performance indicators (ROA and ROE) during the
crisis period, indicative of the fact that higher values of performance ratios due to increased
leverage imply increased solvency risk for banks. The effect of the liquidity ratio on bank
performance is positive both in the period of crisis and the preceding credit boom period,
reflecting the fact that the increased liquidity of banks helps to exploit opportunities presented
directly and at lower cost, thereby increasing their profitability. However, the net stable
funding ratio (NSFR) has a negative effect on both ROA and ROE in the crisis period.
Reduced lending activity or recapitalizations are likely to adversely affect bank profitability
during a stress period. Our findings provide some guidance on the unintended consequences
of new solvency and liquidity standards, viz., new leverage requirements may force banks to
shed highly liquid assets from their balance sheet thereby compromising their ability to
manage liquidity when under stress.

JEL Classification: G01, G21, G28