Get ready for Basel IV

Businessman's hand holding the word 'Risk'The Basel Committee on Banking Supervision (BCBS) doesn’t let up. Not content with the reforms of Basel III, regulators are pressing ahead with much stricter rules for banks that could pose a number of challenges for data management and risk compliance.

'Basel IV' will raise the risk-based capital ratio, revise risk weightings, and make banks move away from model-based assessments. These changes are part of the revamp of capital requirements for operational, market and credit risk.

Neatly enough Basel IV covers four key areas - operational risk, market risk, credit risk and large exposures.

The Financial Stability Board will issue a plan for total loss-absorbing capacity, which includes capital and convertible debt. Regulators want TLAC to be at least double the Basel III total risk-based capital of eight per cent.

But some are concerned that plans to standardise risk modelling go too far.

Wayne Abernathy, executive vice-president for financial institutions policy and regulatory affairs at the American Bankers Association, believes changes to the risk-weighted asset (RWA) regime are so far-reaching and important that they should be dubbed Basel IV.

"As Basel III was an admission that Basel II got things wrong, Basel IV is a clear recognition that there is much that is wrong with Basel III," he told Euromoney. "Yet the folks at Basel have not yet looked in the mirror and asked whether what is mostly wrong might be happening in Basel, that the simple concept of Basel I, to have some basic global capital standards, has been lost in an effort to over-engineer and micromanage at the global level the fine details of capital standards."

In December, the BCBS announced two consultative documents that taken together add up to a pretty sizeable increase in regulatory requirements.

CAPITAL FLOOR

The first consultative document proposed the design of a capital floor framework based on standardised, non-internal modelled approaches.

The proposed floor “would ensure that the level of capital across the banking system does not fall below a certain level”, according to the committee, which also said the floor is designed to mitigate model risk and measurement error stemming from internally-modelled approaches. “It would also enhance the comparability of capital outcomes across banks,” added BCBS.

STANDARDISED CREDIT RISK

The second paper proposed revisions to the standardised approach for credit risk, which seek to strengthen the existing regulatory capital standard in several ways.

These, the regulator said, will reduce reliance on external credit ratings; enhance granularity and risk sensitivity; update risk weight calibrations; and lead to more comparability with the internal ratings-based (IRB) approach with respect to the definition and treatment of similar exposures.

Bank exposures

Under the plans bank exposures would no longer be risk-weighted by reference to the bank's external credit rating or that of its sovereign of incorporation. Instead these would be based on the bank's capital adequacy and quality of assets.

Corporate exposures

These would be based on the firm's revenue and leverage, rather than being risk-weighted by reference to the borrowing firm's external credit rating.

“Further, risk sensitivity and comparability with the IRB approach would be increased by introducing a specific treatment for specialised lending,” added BCBS.

Retail

Meanwhile, the retail category would be enhanced by tightening the criteria to qualify for a preferential risk weight. The plans would also include scope for an alternative treatment for exposures not meeting the criteria.

Residential real estate

BCBS wants to end the 35 per cent risk weight, but instead base weighting on the amount of the loan relative to the value of the real estate securing the loan and the borrower's indebtedness.

Commercial real estate

Two options are under consideration. The first would treat the exposures as unsecured with “national discretion” for a preferential risk weight under certain conditions. The second would see the risk weight based on the loan-to-value ratio.

Credit risk mitigation

“The framework would be amended by reducing the number of approaches, recalibrating supervisory haircuts and updating the corporate guarantor eligibility criteria,” said BCBS.

The consultation period for these two sets of proposals ended March 27th. It will be interesting to see what the response has been and how the Basel Committee will proceed.