December 13, 2016

Basel Set To Fill Bank Capital Holes – With Fudge

by Breakingviews

Global standard setters are set to push fudge into banks’ capital holes. The Basel Committee of banking supervisors’ initiative to harmonise lenders’ risk-weighted assets – known by some as “Basel IV” – should mean capital requirements will rise less than expected, Reuters has reported. European banks will be relieved. U.S. regulators demanding greater uniformity will be slightly miffed, but not surprised.

The key here is the so-called output floor, which could be set at 55 percent before ultimately rising to 75 percent. This means a bank would initially be forbidden from holding less than 55 percent of the capital indicated by the so-called standardised model for measuring credit risk, which uses regulator-determined inputs. The latter is generally more punitive than allowing banks to use their own computer models to assess their assets’ riskiness – and harder to fiddle.

The potential relief could be profound. The original range for the output floor was 60 percent to 90 percent. At the top end, that would imply a rise in risk-weighted assets of 30 percent on average for non-U.S. banks, say Morgan Stanley analysts, who note that RWAs would increase just 18 percent for a 60 percent floor. A lesser requirement initially makes life easier still, given most European banks target or have achieved capital buffers well above their regulatory minimums.

Buffers are intended to cover other things, like accounting changes to loan provisioning and the way trading risk is treated. Still, output floors were always the most daunting prospect, with credit amounting to around three-quarters of a typical bank’s RWAs – and the rest split between market and operational risk.

More watering-down elsewhere would help forestall any equity hikes. In the final reckoning, lenders could also be allowed to use their own models to calculate mortgage risk weights, the value of the collateral used to back specialised lending, and some aspects of large corporate and bank exposures – rather than slavishly follow those handed to them by regulators. The Basel Committee’s proposals will need approval from a group of central bank governors and regulators early in January, and some may feel the softening is unacceptable. But with increasing Balkanisation in many other areas of bank regulation, a trade-off was always likely.

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