If you want to see a grown banker cry, the phrase “Basel IV” should do it.
Banks have spent the past few years raising hundreds of billions of dollars of capital, hiring tens of thousands of regulatory staff, shedding trillions of dollars of assets and getting rid of their riskier businesses in order to meet Basel III capital rules. This framework was designed to reduce the risk of a run on the banks.
While Basel III will not be fully in force for another three years, its successor already ranks highly on the list of things keeping global bank bosses awake at night. Basel IV — a term some bankers are giving to a group of proposed rules that will increase the capital requirements of Basel III — looms menacingly for bankers, even though some regulators deny that it exists.
“I remember [regulators] saying there was no Basel III when the whole industry was talking about Basel III,” says Giles Williams, a long-serving partner in KPMG’s regulatory practice. He adds that what regulators are now working on “seems to be a remarkably different package in practice to what came out in 2010” with the announcement of Basel III.
Bankers and regulatory experts expect Basel IV to have three main elements.
The first is an overhaul of the capital treatment of banks’ trading books. Last November, the proposed rules threatened to increase some banks’ capital requirements by as much as 800 per cent. They have been refined since then but still threaten to have a large impact on banks with big securities operations. The overall result is to make trading activities far more expensive for banks than envisaged under the Basel III proposals.
The other two planks of Basel IV are a more pointed departure from Basel III.
Under Basel III, banks’ most important capital ratios are heavily reliant on a calculation banks do themselves. The key capital ratio is banks’ equity divided by their risk-weighted assets (RWA). Banks come up with the RWA number by making a judgment on how risky various loans and other assets are.
The Basel Committee on Banking Supervision is considering restricting the way RWAs are calculated in two ways. First, it will analyse the way banks assess the riskiness of their loan books and is likely to reduce banks’ flexibility in calculating RWAs.
Second, the Basel Committee has just signalled a major overhaul of the way banks calculate operational risk, which includes things like fines, IT failures and cyber crime. Instead of allowing banks to develop their own models, banks will have to use a standardised approach laid out by global regulators.
These reviews were born from regulators’ despair at the wide discrepancies between the RWAs calculated by different banks. A Basel Committee study published in July 2013 showed vast differences in the results of banks’ RWA assessments. While this was mainly because of the different assets the banks held, the researchers said this was partly a result of a lack of consistency among the banks over how they treated the assets.
“Regulators are asking the right question, but they’re ending up with the wrong answer,” says a senior executive at a large European bank, speaking off the record given that relations with regulators are sensitive.
The executive adds that there were legitimate reasons for differences in RWAs: “Having a blunt Basel IV set of standardised RWAs is actually not correct and it’s dangerous.”
The “danger”, widely cited among bankers, is that the new set-up could make banks less sensitive to risk. If there is minimal difference between the capital required for high-risk and low-risk loans, banks might be likely to make more high-risk loans as they will typically carry higher rewards. “The solution to this is not having blunt and equally applying instruments,” the executive says. “It’s having a more intelligent discussion bank by bank.”
Other banks argue that the Basel Committee’s latest initiatives are unnecessary, given the big changes banks have made following the financial crisis.
Banks have overhauled their business models, exiting or radically cutting areas such as trading in favour of less capital intensive activities like advising clients. European banks have raised more than €400bn of equity since 2007. The biggest US banks have improved their capital ratios by more than half since the crisis. Bankers say what their industry needs is regulatory certainty and a period of stability in order for them to rebuild their shattered margins.
Some believe the EU’s new financial services chief, Jonathan Hill, will be an ally in this quest as he seems to be in favour of paving the way for banks to play their role in Europe’s capital markets union.
The global thirst for new regulation, though, appears unquenched. As well as the Basel IV package, the world’s biggest banks have to meet new rules requiring them to have higher levels of capital that can be “bailed in” if a bank runs into trouble. Some now see such evolution as a permanent fact of life.
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