The potential unintended consequences across risk categories of Basel IV implementation

The potential unintended consequences across risk categories of Basel IV implementation

Rajiv Arora

Rajiv, can you please tell the Risk Insights’ readers about yourself and your professional experiences?

Rajiv has over 20 years of investment banking experience managing risk, regulatory and technology transformation programmes, working with senior management to deliver executive/board level objectives and benefits. He has successfully delivered large change programmes building strong relationships with stakeholders while developing, managing and leading high impact teams across geographies. He worked on Basel III regulatory framework for capital adequacy, stress testing and liquidity risk and is now working on the upcoming regulations for FRTB and SA-CCR.

At the Risk EMEA Summit you will deliver a presentation on the potential unintended consequences across risk categories of Basel IV implementation. Why is this a key talking point at the Summit?

With Basel III being rolled out, most banks are requiring greater amounts of capital and liquidity. Leverage Ratio requirements are also putting increased pressure on the size of balance sheet and consequently on the level to which a bank can use their balance sheet for their clients. Thus with a bank’s key resources under constraint, Basel IV requirements are more likely to ensure that additional changes do not further burden these resources and also that the “real” economy is supported by the financial institutions as interest rates start to rise and other economic and political developments start to impact the “real” economy.

Can you explain the consequences this will have on standardised v.s IRB?

The regulators stated intention is to narrow the gap in capital requirements calculated using standardised and IRB approaches. Directionally this will continue though the pace may get slower to allow for the banks under IRB to adjust to the new realities of even higher capital requirements.

What are some of the potential effects that Basel IV’s standardisation will have on the overall business?

Basel IV’s standardisation will require a protracted period of impact assessment to ensure that resources critical for a functional financial market – capital, liquidity and balance sheet – are not unnecessarily constrained as a result of any new regulations being rolled out. There may also be softening of existing requirements and/or more time for thresholds (such as stable funding, leverage ratio etc.) to come into effect.

How do you see the regulatory environment evolving over the next 5 years?

Trump has directed the US regulator to be more selective in the regulations being adopted as well as softer in their requirements. As an example, the Trump administration is considering “undoing” Volcker and Dodd-Frank regulations. Thus the Trump effect will mean that all non-US jurisdictions will have to ensure that they do not give the US financial institutions an unfair business advantage by creating a regulatory arbitrage due to speedier implementation of the Basel requirements.

It is likely we will see Basel standards implemented to varying degrees across different regions. In some countries (such as in Japan), the Basel standards have implemented to the letter of the BCBS standard. In other regions (such as in the EU), there is an increasing pressure on regulators to tailor the BCBS standards to meet the needs of the region concerned. It is unclear how the EU and other regions will react to the US plans to deregulate. It is clear that relaxing some standards will create an un-level playing field for non-US banks competing against their US counterparts. This will undoubtedly put pressure on other non-US regions to also deregulate. This is already evident as BCBS who have been unable to finalise the Basel III package which has been delayed since Dec 2016.


 

It is worth noting that the Basel Committee on Banking Supervision (BCBS), to date, has only released Basel III standards. The global standard setters are still seeking to finalise Basel III and have not yet proposed a Basel IV framework. We expect Basel III will be finalised only after the BCBS finalise their standards on credit risk, operational risk and model floors. These standards are delayed but expected before the middle of 2017.

Some market participants have incorrectly referred to the revised Basel requirements (eg FRTB, SA-CCR & NSFR) as Basel IV. These requirements really form part of the Basel III framework. They have recently been translated into draft EU law via the proposed CRD V package. We can only hypothetise on what may be included in the BCBS’s next Basel Accord iteration.

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