Bank Capital Requirements: Basel Committee Releases Standards to Finalize Basel III Framework

Sullivan & Cromwell LLP - December 19, 2017

On December 7, 2017, the Basel Committee on Banking Supervision released standards to finalize its Basel III capital framework (commonly referred to as “Basel IV”).  The Basel III capital framework was published in December 2010, and, since then, has been supplemented and revised by numerous standards published prior to December 2017.  Although the Basel III capital framework primarily addressed the components of regulatory capital (i.e., the numerator of capital ratios) and the calibration of minimum required capital ratios (i.e., the minimum percentages), Basel IV largely focuses on the denominator in capital ratios—in particular, risk-weighted assets (“RWAs”) for purposes of the risk-based capital ratios.

The Basel Committee describes Basel IV as finalizing post-crisis regulatory reforms for capital adequacy, but it is likely that the international framework for the regulation of bank capital will continue to evolve.  Indeed, Basel IV and the Basel Committee’s accompanying materials note that the Basel Committee will (i) review the calibration of the revised market risk framework prior to its implementation on January 1, 2022, (ii) monitor the impact of leverage capital requirements on central clearing of derivatives and, by December 2019, conclude a review of the impact of leverage capital requirements on the provision of clearing services and resilience of central clearing, and (iii) review the treatment of credit loss provisions for purposes of calculating the output floor in light of the upcoming implementation of revised provisioning standards based on forward-looking expected credit loss methodologies.

According to the Basel Committee, Basel IV is intended to, among other things, reduce variability in RWAs among banking organizations while not significantly increasing overall capital requirements.  Basel IV seeks to reduce variability in RWAs by (i) eliminating model-based approaches for certain categories of RWAs (e.g., operational risk RWAs and credit risk RWAs for equity exposures), with the effect that all banking organizations must apply a standardized approach to those categories, and (ii) where model-based approaches remain available, reducing the scope of model-based parameters and implementing exposure-level parameter floors.

With regard to the overall effect on capital requirements, the Basel Committee published a study that presents the Basel Committee’s assessment of the quantitative impact of Basel IV; however, Basel IV will likely have significant and wide-ranging effects extending beyond the impact on overall capital requirements.  Its ultimate impact will depend substantially on how Basel IV is implemented by national authorities.  Basel IV, together with the revised market risk framework published in January 2016 (commonly referred to as the fundamental review of the trading book or “FRTB”), will significantly change bank capital requirements.  Moreover, as discussed below, for U.S. banking organizations, there are many open questions on how the U.S. banking agencies will implement Basel IV and integrate it with the capital adequacy framework that has developed since the financial crisis and that will no doubt continue to change as Basel IV implementation approaches.