The capital requirements of the Basel III proposal may put a damper on lending in Massachusetts, according to industry experts watching the new rules develop.

Since its release in early June, Basel III has been the subject of dread uncertainty among bankers as their lawyers and accountants keep tabs on how the global rules may ultimately affect banks in the Bay State.

Giant accounting firms like KPMG have published lengthy, complicated reports on Basel III, but how well the present findings of those reports will match the final version of the new rules remains to be seen.

In fact, much remains to be seen, and that’s exactly what has industry experts worried.

Basel III is the result of months of negotiations between the 27 countries that make up the Basel Committee on Banking Supervision. As it stands, it triples the size of the capital reserves banks are required to hold against losses.

In response to the global economic crisis, Basel III sets a new key capital ratio of 4.5 percent. The current standard is 2 percent. A buffer of 2.5 percent is also included. If a bank’s capital falls within the buffer, it will be restricted on paying dividends and bonuses.

The new rules are scheduled to be phased in between Jan. 2013 and Jan. 2019.

Prohibitively Expensive

The Basel framework is extraordinarily complex, and because it is being crafted largely by Europeans, its primary concern is with the 20 or so banking giants that control the market across the Atlantic. How that ultimately translates to Massachusetts, which is waist deep in community and regional banks, is where things get troublesome.

“It’s huge, and there’s so much that’s left undecided,” David Woronov, partner at Boston-based law firm Posternak, Blankstein & Lund, told Banker & Tradesman. “I’m looking at reports from January that say, ‘American banks, don’t worry, you can use mortgage servicing rights toward capital.’”

Six months later, it turns out mortgage servicing rights cannot be counted toward capital for the purposes of complying with Basel III.

In a recent report, KPMG suggests banks sell all or part of their insurance subsidiaries. Of course, KPMG would appreciate it very much if banks would retain them to take care of this and many other transactions.

“That’s part of the problem,” Woronov said. “It’s going to create markets that will be too expensive for your local bank. These products will be so expensive as to be prohibitive.”

Even foregoing those expensive products, Massachusetts’ banking industry is well capitalized in general, but will nevertheless be required to do the work of complying with Basel III.

“I don’t think the overall numbers are going to be an issue for our banks,” Massachusetts Bankers Association Executive Vice President Jon Skarin told Banker & Tradesman. “But it is extraordinarily complex. A bank looks fine on a Tier One capital level, but they’re going to have to go in and do more work, more formulations, more calculations. I don’t even know if the regulators have their full hands around it.”

“Is it really necessary to have a $2 billion bank lumped in with a $500 billion bank as far as what the rules are? Probably not,” Skarin said. “Here, we have banks under $10 billion, and they’re not horribly complex institutions. They operate only in Massachusetts, they don’t have securities trading, they don’t do credit default swaps. To hold them to the same standard as Citibank; I don’t know if that makes a lot of sense.”

Preliminary Discussions

Also, certain nuances are lost in translation between Europe, where the Basel standards are drafted, and the United States.

“We have a very different banking system than the Europeans,” Skarin said. “Their focus is on large, multinational financial institutions, that’s primarily what they have over there. Capital levels for them, it’s different for the U.S. market. In the U.S., the more capital you have to hold, the less lending you can do. It’s not necessarily a threat [to banks], it’s just more complexity, and it could potentially constrain their business.”

Woronov said despite the consequences that are going to be felt by local banks as a result of Basel III, they and the industry’s giants do have significant tracts of common ground.

“It’s really hard on local banks, but it’s equally hard on the huge international banks, too.” Woronov said. “It’s a political process, and [banks] are going to have more issues with the same question marks. How do we do the valuation? The whole point of Basel III is to reduce risk, but that presupposes that it can be determined without a question, across the board, what is a risky asset and what is good for all geese is good for all ganders.”

When it was released June 7, Basel III carried a 90-day comment period. American industry groups are pushing for an extension of that time.

Several banks declined Banker & Tradesman’s invitation to comment for this story. One industry executive did say Basel III would “have a lot of people heading for the exits.”

But Skarin doesn’t quite see it that way.

“In the end, what do we gain out of it?” Skarin asked. “I’m not sure we’re gaining a lot.”

“We’ll be talking about this until 2020,” Woronov said.