What is Basel IV?
On December 7, 2017, the Basel Committee on Banking Supervision (BCBS) published the Basel III: Finalising post-crisis reforms document. It contains what the BCBS terms as revisions to the Basel III standards on credit risk, credit valuation adjustment risk and operational risk. The document also prescribes minimum capital requirements as a percentage of risk-weighted assets (RWAs) to apply to all banks, whether using the standardized approaches or internal ratings-based (IRB) approaches, and sets out requirements for the controversial leverage ratio. The BCBS considers that the revisions complete the Basel III Framework but European banks generally consider the revisions to go far beyond the original Basel III standards, and thus the disputed name.
So that’s Basel III done and dusted then?
Hardly. Most jurisdictions are still making law and regulations to apply the Basel III standards, which were supposed to come into force globally by the end of 2015. Most recently, European Union (EU) lawmakers adopted wide-ranging amendments to Regulation (EU) 575/2013 on prudential requirements for credit institutions and investment firms (CRR) and Directive 2013/36/EU on access to the activity of credit institutions and investment firms and the prudential supervision of credit institutions and investment firms (CRD IV), which will apply some of the last Basel III standards including the leverage ratio and the net stable funding ratio. Most of these amendments to CRR and CRD IV will apply only from Q3 2021.
Anything on trade finance?
- The revisions to the standardized approach to credit risk (SA-CR) include more granular, and seemingly less risk-sensitive, requirements for specialized lending such as commodities finance. The revisions would align treatment of certain corporate exposures under the SA-CR and IRB approaches and include a 100 percent risk-weight to apply where the corporate does not have a credit rating. The BCBS considers the impact on bank specialized lending to be limited but European banking lobbies disagree.
- The SA-CR revisions would also require banks to convert off-balance sheet items such as letters of credit to credit exposure equivalents using a range of credit conversion factors (CCFs). The BCBS prescribes a blanket 40 percent CCF to all commitments regardless of the maturity of the underlying facility (unless a lower CCF applies). The BCBS departs from current treatment to prescribe a 10 percent CCF for all unconditionally cancellable commitments, with a discretion for national supervisors to apply a higher CCF if considered appropriate. It also prescribes raising the CCF for transaction-related contingent items, including standby letters of credit related to a particular transaction, from the current 20 percent to up to a new maximum of 50 percent.
- The controversial output floor would raise minimum capital requirements for banks using the IRB approach, and in doing so it would wipe out most regulatory capital savings on credit risk. Banks using internal models would be required to calculate their minimum capital requirements on the basis of standardised (or floored) RWAs with the first floor being set at 50 percent of floored RWAs and rising to 72.5 percent by 2027. The impact of the output floor is expected to be most pronounced on credit risk, and will likely reduce the appeal of traditionally low-risk businesses like trade finance for some banks.
When will the revisions apply?
Probably not before 2024. The BCBS has set a five-year transition period for the revisions with most revisions to standards supposed to be applied by supervisors by January 1, 2022. However, few jurisdictions are likely to have transposed the revisions into law by then, and any that have will likely be reluctant to move before either the EU or United States (US) do. And neither of these heavyweights will have done so by 2022. We expect EU policy-makers to publish draft legislation transposing the revisions by the end of Q1 2020. This legislation is unlikely to apply before early 2024.
What should I be doing?
Lobby up. Most governments will transpose the revisions with greater or lesser divergences from what was agreed in Basel to suit domestic banks and other stakeholders. This will certainly be the case in the EU, where the European Commission has consistently proposed (and gotten away with) some tailoring of BCBS standards when transposed in EU law. The Commission began its work on amending CRR and CRD IV to transpose the revisions early last year. The Commission is expected to publish the draft legislation after a new College of Commissioners takes office in November. Early problems identified by European banking lobbies include the scope of the output floor (with the priority being to exclude EU-specific buffers) and the treatment of exposures to companies and small and medium-sized enterprises in the SA-CR revisions. Banks and others concerned about the impact of the revisions on trade finance should be making these concerns known to Commission policy-makers now and make the case for limited divergence.