The Basel Committee negotiators finally got there. The so-called Basel IV framework has been agreed and is not as harsh as many bankers had feared, but now comes an even harder part: implementing it consistently across the world. By Justin Pugsley.

What has happened?

Reg Rage has rated the latest Basel deal as ‘reg-zen’ on the rage-ometer as it creates that rarest of commodities these days: a degree of certainty. The agreement has been dubbed ‘Basel IV’ by the market but is called Basel III by the Basel Committee.

But Christmas has not come early for banks. They will face more regulation, but it looks as if, for the most part, capital requirements will not soar for the majority of banks just as the Basel Committee promised. However, the committee identified four big banks that will be hit relatively harder due to the leverage ratio buffer for global systemically important banks (GSIBs).

Reg Rage Zen

The Basel Committee estimates the total capital shortfall for big banks will be €90.7bn, a manageable sum. A well-trailed measure is the output ‘floor’ levied on bank internal risk models, which will be constrained to 72.5% of what the committee’s standardised approach would produce to reduce variability. The number is a compromise between Europe and the US. Also, the leverage ratio for GSIBs, which takes the form of Tier 1 capital, is set at 50% of a GSIB’s risk-weighted capital buffer.

The floor will hit European banks hardest, but has a five-year implementation period starting from 2022. The European Banking Authority found from a sample of 88 EU banks that they would face a 12.9% increase in minimum required capital. However, the committee has made the standardised approach, used by most banks, more granular and risk sensitive – that is, potentially less capital intensive.

Other measures include reviewing the controversial Fundamental Review of the Trading Book (FRTB) and moving its implementation date from 2019 to 2022, aligning it with the start date for the revised credit and operational risk provisions. Capital requirements for exposures to big corporates have been made more granular and effectively lowered for high-quality credits. And instead of withdrawing the use of advanced and foundation internal risk-based approaches for banks with their own models, the committee will only remove advanced ones.    

Why is it happening?

The reason for the compromises is that it was the only way to get a deal, as no deal would have been a worse outcome. Also, dragging out the negotiations too long risked losing momentum on global reform.

What do the bankers say?

Overall, bankers are relieved. Much of what has been finalised was less onerous than what was being proposed in earlier Basel Committee consultations. However, the devil is in the detail. Over the coming weeks these will be poured over and doubtless there will be sighs of relief and some wincing over the fine print. One major area of scrutiny will be the credit valuation adjustment framework, which has been recalibrated.

Will it provide the incentives?

The aim of the latest iteration of the Basel framework is to make a global financial crisis less likely. It has forced banks to carry more and better quality capital (since the crisis, the largest global banks have raised more than $1500bn in new common equity Tier 1 capital), to re-examine their risk practices and for supervisors to be more involved.

But it would be brave to declare banking crises as vanquished. Consider that, since the 1970s, there have been steadily more frequent and damaging banking crises despite being accompanied by a growing body of regulation. Does Basel IV really mark a full stop in that trend?  

Much depends on how various jurisdictions implement the framework. There are parts some do not like, such as the curbs on internal models in Europe and the US; other countries are not keen on the FRTB or some liquidity measures. Also, the EU’s legislative process may mean it will be late on implementation and Basel IV could clash with the US’s deregulation agenda.  

As a senior partner at Deloitte recently put it: “We may have passed peak regulatory convergence” – and what lies ahead is a degree of fragmentation as jurisdictions water down the bits of the framework they dislike, or take forever on implementation. For the creative, this presents tantalising regulatory arbitrage opportunities.  

But Basel only covers banks. Shadow banking – a rather vague and emotive term – could be a source of future financial crises. Though much activity is legitimate and useful, some shadow firms escape the full scrutiny of supervisors, leaving blind spots in the financial system. The problem with so strongly regulating one part of the financial system is that risks will naturally gravitate to where the rules are more lax or simply different.

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