The “Basel III endgame,” a comprehensive plan for stronger bank capital requirements aimed at ensuring the viability of large banks, will be unveiled by US banking regulators later this week.

Regulators have stated that the rules will apply to banks with $100 billion or more in assets, though specifics are still unknown. They are anticipated to fundamentally alter how the largest banks manage their capital, which would have an impact on their lending and trading operations.

According to banks, requiring more capital is unnecessary and will harm the economy.

What Is The Goal of ‘Basel III’?

The Bank for International Settlements (BIS) in Basel, Switzerland, organised the Basel Committee on Banking Supervision to ensure that regulators around the world adhere to the same minimum capital criteria so that banks can withstand loan losses in difficult times.

The “Basel III” norm of the committee was decided upon during the world financial crisis of 2007–2009. Numerous capital, leverage, and liquidity criteria are included. Many of those rules have been implemented by regulators around the world for years; the so-called “endgame,” decided in 2017, is the most recent iteration.

The “endgame” concept improves Basel’s method for allocating capital based on how risky a bank’s operations are. The U.S. proposal will address a number of significant elements, including as credit, market, and operational risks.

Credit Danger

The capacity of banks to utilise their own internal risk models to determine how much capital should be maintained against lending operations, including mortgages or business loans, is anticipated to be abolished by American authorities.

Michael Barr, vice chair for supervision at the Federal Reserve, said that because banks are motivated to keep their capital costs low, these internal models frequently understate risk. Instead, authorities should set consistent modelling requirements for all major banks.

Market Danger

The proposal is also anticipated to establish new standards for how banks assess the risk posed by market fluctuations and potential trading losses. These trading dangers, according to regulators, are now being overstated.

Banks will be allowed to continue using internal models that have regulator approval when evaluating these risks, while Barr has stated that standardised models may be necessary for exceptionally complex issues. Additionally, rather than modelling trading risks at the overall level, banks will now need to do so at the level of the specific trading desk.

All things considered, the modifications are anticipated to lead to increased capital requirements for banks with significant trading operations.

Operational Risk

One significant new area of the Basel Endgame is estimating operational risk. This refers to the possible losses that banks can experience from unforeseen sources, such as unsuccessful internal policies, poor management decisions, costly legal actions, or uncontrollable external events.

Similar to credit risk, regulators want to replace current internal models with a standardised method that would account for a bank’s numerous operations and previous operational losses when determining capital levels.

Banks have cautioned that this strategy may cause some banks that substantially rely on non-interest fee income, like credit card and investment banking fees, to incur dramatically higher costs. Banks caution that if those costs are not capped, an operational risk model that includes them could result in disproportionately higher capital requirements for some businesses.

Why Do Banks Don’t Agree?

Banks had hoped that US regulators would provide capital relief elsewhere in their rule book even though the rules had been in the works for years. They contend that any capital increases are unnecessary because banks are adequately capitalised, having endured the COVID-19 pandemic and routinely passing the Fed’s yearly stress tests.

The complete implementation of the Basel agreement might result in capital increases of up to 20% for some large banks, according to Randal Quarles, the former head of the Fed’s regulatory agency. This month, Barr stated that the majority of banks now have sufficient capital to meet the standards, and those that still need to raise money might do so by deferring paying dividends for fewer than two years while doing so.

However, the current set of regulators, all of whom were nominated by President Joe Biden and are Democrats, have not demonstrated any willingness to ease up on Wall Street. They have cited the demise of three lenders earlier this year as proof that they must continue to exercise extreme caution.

(Adapted from Reuters.com)