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

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.