Simon Hills, Director, Prudential Policy, UK Finance
Last Thursday, the Governors and Heads of Supervision (GHoS) of the Basel Committee on Banking Supervision (BCBS) declared they had successfully finalised the Basel III framework. The process had started in December 2014 with proposals to revise the standardised approaches to calculating credit and operational risk, limiting the ability for banks to model credit risk for some lower default portfolios using internal ratings based (IRB) approaches. This caused the industry some concern about the amount of extra capital banks would have to hold against unexpected losses. Since then, as a result of good quality dialogue, by industry bodies such as UK Finance with the BCBS, the proposed framework has iterated to a more reasonable solution which should see no significant increase in capital. The last piece in the jigsaw was the agreement of the 72.5per cent output floor which will cap the regulatory capital diferential for banks model credit risk weighted assets compared to the application of the more conservative standardised approach.
It is clear the setting of the output floor at the mid-point of the 70 to 75per cent range that had been under discussion for more than a year had been a bone of contention between members of the BCBS, some of whom had different views about the ability of banks’ models to properly assess credit risk. The five-year phase in period from the planned 2022 implementation date, as well as the newly and sensibly, in my view, extended implementation period for the Fundamental Review of the Trading Book were the implicit trades that needed to be made between BCBS members to get the deal done.
But focussing on the output floor ignores other elements of the finalised framework that achieve the shared industry and regulatory objectives of making it more risk sensitive by aligning standardised risk weights more closely with the IRB approach.
In particular UK Finance’s specialist and challenger banks will welcome the realignment which should have the added benefit of increasing competition and consumer choice in the important UK mortgage market.
UK Finance had been particularly concerned about the impact of the original proposals on Buy-to-Let (BTL) mortgages. I am particularly pleased that the BCBS listened to these arguments and has moderated the BTL risk weights to reflect the actual risks that this type of mortgage product poses to lenders.
As far as I can tell there will not be a significant increase in capital across the banking industry as a whole, but it remains to be seen as to whether there will be winners and losers amongst individual banks.
The BCBS is to be congratulated on finalising the Basel III framework. Banks and their investors can now get on with the important business of understanding the impacts of the finalised framework on their evolving business models and get on with raising any additional capital.