Basel III endgame, finalizing FRTB implementation

In July of 2023, the Federal Reserve, Office of the Comptroller of the Currency and the FDIC released their joint proposal to update U.S. capital rules to come into alignment with the current version of the Basel Committee’s international capital standards. 

Over the second half of 2023, the agencies have also been working with the industry on quantitative impact studies meant to assess the expected capital impact of the proposal. In January 2024, Federal Reserve Vice Chair for Supervision Michael Barr indicated that the agencies will make their analysis of the findings public, and open another comment window to gather feedback.

Following the financial crisis of 2008-2009, governments and regulators across the globe took steps to shore up the financial system and bolster oversight of financial institutions. During that time, the Basel Committee on Banking Supervision, a group convened by the Bank for International Settlements (BIS), significantly revised its capital framework to strengthen the regulation, supervision and risk management of banks–also known as the Basel III Framework. 

It is important to note that the Basel Committee has no founding treaty, and it does not issue binding regulations. Rather, it serves as a forum for the development of policy solutions and standards which then have to be agreed to and implemented by each nation, following their respective regulatory and legislative processes. This process produces fairly consistent regulatory regimes, albeit with some variations across jurisdictions. The US Basel III Endgame proposal is no different.

The US proposal, which was issued on July 27, 2023, came in the wake of the collapse of Silicon Valley Bank and Signature Bank, and the subsequent turmoil in the banking sector, which caused regulators, who were still in the process of writing the proposal, to reconsider the scope and applicability of core components of the Basel III framework. 

Following the issuance of the proposal, and throughout the fall, Congress held hearings exploring the impact of the proposal on the banking sector and provided members with the opportunity to express a number of thoughts and concerns. 

While concerns with the proposal have been bipartisan, opposition to the proposal has been particularly acute among Republicans. Not long after its release, the House Republican caucus demanded regulators rescind the proposal, arguing that the proposal was fatally flawed and amounted to a back door attempt to roll back the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018. 

That bill, which increased certain capital thresholds from $50 billion to $250 billion and introduced a tailored approach to bank capital required, was passed during the Trump Administration and had been characterized by some as a “rollback” of the post 2008 financial crisis Dodd-Frank reforms. 

Democrats have also expressed concerns with the Basel III Endgame proposal on a variety of fronts, including that the proposal would make it more difficult for banks to make loans under a “special purpose credit program” which is aimed at making it easier for individuals from historically disadvantaged communities to obtain home loans and for increasing the amount of capital banks would need to hold to invest in clean-energy tax credits. 

In the months leading up to the release of the proposal, officials involved in its development indicated that in the wake of the collapse of the Silicon Valley and Signature Banks, the proposal would ultimately increase capital requirements across all banks with $100 billion or more in total assets. At a high level, the proposal would require banks with total assets of $100 billion or more to: include unrealized gains and losses from certain securities in their capital ratios; comply with the supplementary leverage ratio requirement; and comply with the countercyclical capital buffer, if activated.

The proposal was well choreographed in advance of its release, but that did not result in unanimous passage, with the FRB voting 4-2 in favor and the FDIC voting 3-2 in favor. Even among those who voted to publish the proposal, Chair Powell indicated an openness to “potential modifications”. In particular, the Chair expressed interest in public feedback on:

• The calibration of the proposed capital increases, both overall and for specific areas such as capital markets activities and operational risk.
• Ensuring the right balance for firms with assets between $100 billion and $250 billion.
• Ensuring the consistency and anti-arbitrage benefits of the new proposed standardized approaches outweigh the costs of treating some very different activities as identical, which the Chair is concerned could reduce risk capture and discourage less risky activities.

Zooming in a bit, the proposal revises the capital framework for banks with total assets of $100 billion or more in four main areas: credit risk, market risk, operational risk, and credit valuation adjustment risk. In short, the proposal significantly reduces the differences across the four categories of banks (Categories I-IV, segmented by total assets), which were established in 2019 for the purposes of creating regulatory capital requirements. Category III and IV banking organizations with total consolidated assets between $100-700 billion would see the biggest changes, with capital calculations now being more aligned with those currently applicable to Category I and II banks. 

The proposal also changes the capital treatment of single-family mortgages, increasing the risk weights and potentially impacting larger banks participation in mortgage related businesses; and would require firms to use an expanded risk-based approach for calculating credit risk capital requirements, turning away from the internal model approach and providing more risk sensitivity.

These are a snapshot of this expansive proposal and the political climate surrounding its release. The challenge for regulators in the months (and likely years ahead) is to incorporate feedback from the market and build consensus around a rule that is defensible and appropriately calibrated.

How Bloomberg can help

To help firms navigate the Basel III endgame and the finalization of FRTB, Bloomberg provides both enterprise data and analytical solutions. Whether firms require FRTB-ready market data, a reliable risk analytics engine or a full end-to-end workflow, Bloomberg can customize a package to meet specific requirements across all major jurisdictions.

To hear more FRTB implementation and data challenges, view our latest webinar, Basel III endgame & FRTB implementation: How to solve for US divergence, Funds challenges and HPE, or read our industry perspective blog series sharing views from APAC and London.