Basel III reform: "a major lesson from the financial crisis has been learned"

The oversight body of the Basel Committee on Banking Supervision, the Group of Central Bank Governors and Heads of Supervision (GHOS), endorsed the Basel III reform package at its meeting on 7 December 2017. These measures are designed to strengthen financial stability and promote harmonised regulation of the banking sector. The GHOS meeting wrapped up the last outstanding issue by setting the output floor for capital requirements calculated using internal models for risk-weighted assets (RWAs) at 72.5%. In effect, the output floor caps the potential capital saving these models offer at 27.5%, compared with the figure produced by standardised approaches.

Speaking in Frankfurt am Main, Mario Draghi, President of the ECB and Chairman of the GHOS, hailed the endorsement as a "major milestone that will make the capital framework more robust and improve confidence in banking systems." Stefan Ingves, Chairman of the Basel Committee and Governor of Sveriges Riksbank, said it was now up to every country to implement this package: "Now that the Basel III regulatory reform agenda is complete, we must focus on the important task of ensuring the standards are implemented consistently around the world."

Not an ideal outcome, but a compromise everyone can live with

Bundesbank President Jens Weidmann and BaFin President Felix Hufeld represent Germany in the GHOS. "The conclusion of the Basel III reform package is important because it means that, eleven years on from the outbreak of the financial crisis, another major lesson has finally been learned," Mr Weidmann explained, adding that it also eliminates the regulatory uncertainty that was weighing on banks. The Basel III reform package was developed in 2010 on behalf of the G20 and has been on the negotiating table ever since. BaFin President Felix Hufeld called the now-endorsed output floor a compromise that all the stakeholders can live with, but hardly the outcome Germany had been hoping for: "What mattered to us was that the global banking regulation regime does not depart from the principle of risk sensitivity and that it continues to permit the use of internal models."

The European Banking Authority (EBA) welcomed the endorsement of the Basel III reform package. The European Commission announced that its implementation of the Basel III rules will take into account the particular circumstances of European credit institutions although, as Commission Vice-President Valdis Dombrovskis noted on Thursday in Brussels, the rules apply to all banks. These rules need to be implemented in full, and the Commission will now carry out a thorough and detailed impact assessment.

More transparency around credit, market and operational risk

Besides the output floor, the GHOS members agreed on special arrangements for the roll-out of the reform package. The revisions will take effect from 2022, but the entire phase-in period will last up to and through 2026. During this period, the output floor will increase incrementally. At national discretion, the increase in RWAs stemming from the application of the output floor can be capped at 25% until 2027. The capital requirements for this are calculated on the basis of a bank's RWAs. Moreover, from 2022 banks will have to report the RWAs they calculate for credit, market and operational risk using the standardised approaches. This should enable market participants to gauge the effects of internal bank models as compared with the standardised approaches.

The Basel III reform package also includes changes which will improve the granularity and risk sensitivity of the standardised approach for credit risk. One will permit banks to treat real estate exposures favourably if the loans are well collateralised and if the banks had to realise only small losses in the past. Another will assign exposures to small and medium-sized enterprises lower risk weights in future, moving from 100% to 85%. Banks will no longer be permitted to use internal models when calculating operational risk, which encompasses the risk of losses stemming from the inadequacy or failure of internal procedures, people or systems or from external events. From 2022, there will be just one standardised calculation method sanctioned by supervisors.

The GHOS members also agreed that global systemically important banks (G-SIBs) will have to maintain a higher leverage ratio in future. This leverage ratio G-SIB capital buffer is set at 50% of a G-SIB's risk-weighted higher-loss absorbency requirement.

As for the issue of the regulatory treatment of sovereign exposures, the members of the GHOS agreed that the current framework should remain unchanged until further notice. The Committee has issued a public call for comment on a series of questions to inform its longer-term thinking on this issue.