Basel III post-crisis regulatory reforms finalised

Introduction

The Basel Committee on Banking Supervision (BCBS) has announced that agreement has been reached on the outstanding elements of the Basel III post-crisis regulatory reforms. The package of reforms, which was endorsed by the BCBS’s Group of Central Bank Governors and Heads of Supervision (GHOS), focuses on standardising banks’ approach to calculating credit risk, risk-weighted assets and operational risk, thus ensuring better worldwide comparability of banks’ risk-based capital ratios.

Global regulators have hailed the breakthrough as a victory for transparency and comparability. ECB President Mario Draghi has gone as far as stating that the agreed package “completes the global reform of the regulatory framework.” Yet focus now shifts to implementation, with consistency and comparability being key objectives of regulators going forward.  

What are the main features of the 2017 reform?

The finalised package of Basel III regulatory reforms has five main features:

1. Strengthening risk sensitivity and comparability in credit risk by adopting minimum “input” floors for metrics such as probability of default (PD) and loss-given-default (LGD), removing the option to use the advanced IRB approach for certain asset classes and additional enhancements to reduce RWA variability.
2. Introducing a standardised approach to CVA risk based on fair value sensitivities to market risk factors, and adding an exposure component to account for potential mark-to-market losses of derivative instruments caused by deterioration in counterparty creditworthiness.  
3. Introducing a standardised approach to operational risk, which bases a bank’s operational risk capital requirements on two components: income and historical losses.
4. Providing a safeguard against unsustainable levels of leverage by adding a leverage ratio buffer for global systemically important banks (G-SIBs), set at 50% of their existing risk-weighted higher-loss absorbency requirements, and which must be met with Tier 1 capital.

Revising banks’ output floor to a minimum capital output of 72.5% of total risk-weighted assets calculated using only the standardised approaches agreed in the Basel III reforms, though internal approaches which have regulatory approval may be used if they produce higher outcomes.

A more gradual implementation timeline

The implementation deadline for most of the agreed reforms has been set at 1 January 2022. However, the BCBS has chosen to bring the standardised output floors into force at a more gradual pace through an added five-year phased implementation period (50% in 2022, rising almost linearly to reach 72.5% in 2027).

The objective of these transitional arrangements is to give banks more time to adjust to any increases in capital requirements determined by the new frameworks. This transitional period may, however, prove to be elusive should market forces compel faster implementation, particularly with respect to banks perceived to have shortfalls under the framework.

Not the end of the road

The agreement reached by global regulators is without doubt a major achievement, yet talk of “finalisation” of the Basel III negotiations is premature at best. Asked for his comments, Deloitte’s EMEA Lead for Regulatory Strategy David Strachan stated that, “a lot still has to happen before these standards are finalised and implemented, and these steps may yet present banks with more uncertainty and complexity that they had bargained for.”

Deloitte’s Centre for Regulatory Strategy envisages five key issues to watch out for in the coming months, including:

1. The evolution of the discussion on the emerging detail of the underlying workings of the new frameworks;
2. How markets react to the transitional arrangements proposed to banks;
3. The commitment of all parties to implementation of the agreed standards;
4. The approach to be adopted by EU policymakers to transposing these new standards into EU law; and
5. Unfinished business, such as the formal decision to delay the implementation of the Fundamental Review of the Trading Book from 2019 to 2022, and the treatment of sovereign risk on bank balance sheets.