Global Regulators Meet to Wrap Up Basel III: The Main Issues

  • Draghi, Ingves will speak to the press in Frankfurt at 5 p.m.
  • Work on the capital framework began in response to the crisis

The headquarters of the Bank for International Settlements (BIS) in Basel, Switzerland

Photographer: Bloomberg/Bloomberg

Global bank regulators convene on Thursday to close the book on Basel III, a sweeping set of capital rules begun in the aftermath of the financial crisis.

At 5 p.m. in Frankfurt, European Central Bank President Mario Draghi, who heads the oversight body of the Basel Committee on Banking Supervision, and the regulator’s chairman, Riksbank Governor Stefan Ingves, will reveal the outcome of the meeting. While a last-minute hiccup can’t be ruled out, people familiar with the talks expect a deal to be reached on the last pieces of the framework.

The final phase of Basel III is focused on the statistical models that banks use to measure their risk of losing money on investments, part of determining their capital requirements. Regulators took action when these models failed to deliver accurate risk estimates during and after the financial crisis. They also wanted to address the wide variability of results across banks, which raised concerns that lenders were gaming the rules.

Here are the most important decisions Draghi and Ingves are likely to announce. This list is based on the Basel Committee’s public proposals, internal documents and information provided by people familiar with the talks.

Output Floor

The main stumbling block in the negotiations for most of the last year was a measure that restricts how low banks can drive their capital requirements by gauging asset risk with their own models, a practice that has been around for about a decade. Under the compromise plan, banks’ total assets weighted for risk using their own models can’t be less than 72.5 percent of the amount calculated with a formula provided by the regulators, known as the standardized approach.

This floor is intended to guard against excessively optimistic assessments and to level the playing field with banks that use the standard formula.

Phase-In Period

The output floor will be introduced gradually to allow banks time to adjust, probably starting in January 2022 and reaching its final level five years later. The idea is to give banks time to adjust.

Laurent Mignon, chief executive officer of Natixis SA, for example, said last month that between now and 2027, the firm will have “plenty of time on acting on our books in order to make sure that it doesn’t bite at all.”

Standardized Approaches

The Basel Committee has also overhauled its standardized approaches to measuring credit and operational risk that are used by most of the world’s banks. For Europe’s biggest banks, lending accounted for 82 percent of risk-weighted assets at the end of the third quarter, followed by operational risk at 12.7 percent and market risk at 5.3 percent, according to the Association for Financial Markets in Europe.

Altering the set formulas also affects the impact of the output floor. In both cases, the regulator’s intention was to make these formulas more risk-sensitive and easier to use. To increase transparency and comparability, the big banks that use internal models will also be required to publish their risk-weighted assets calculated with the standardized approach.

Mortgages

The output floor will have a big impact on mortgages, where internal models and the standardized approach can diverge widely. To moderate the impact, the committee has allowed technical measures that effectively reduce the starting point at which the floor is applied, including “loan splitting” and a cap on input variables.

Large Corporates

The Basel Committee may rule out the use of internal models for equity holdings and for loans to other banks and large corporations, also known as low-default portfolios, arguing that the data for modeling are too thin. A proposed new standard model instead used credit ratings for determining risk weights.

Operational Risk

Internal models for operational risk -- potential losses from litigation, penalties or technical failures -- will be replaced by a standardized approach. Parameters used to determine the risk will be phased to make the impact more gradual.

Trading Book

The Fundamental Review of the Trading Book, a comprehensive reform of the standards for banks’ trading businesses that was agreed last year, will be sent back for further work, and its start date pushed back by three years years to January 2022.

Leverage Ratio

Globally systemic banks face a surcharge on the leverage ratio, a measure of a bank’s equity that doesn’t take risk weights into account. While all banks need Tier 1 capital of at least 3 percent of the leverage exposure measure, a proxy for total assets, the biggest banks will face a surcharge on top of that amount.

— With assistance by Nicholas Comfort

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