On March 15, 2017 the Basel Committee on Banking Supervision published a second consultation paper on guidelines for the identification and management of step-in risk. The first consultation on the topic in December of 2015 set out a framework for identifying and managing step-in risk – the risk that a bank might support unconsolidated entities, beyond any contractual obligation, to protect itself from any reputational damage arising from its connection to such entities. This second consultation takes into consideration comments received on the first proposal, includes proposed reporting and other templates to regulators, and offers a timetable for adoption of the framework.
According to the Basel Committee, the proposed framework is intended help to mitigate potential problems at shadow banks from spilling over to banks. The consultation is part of the G20’s larger initiative to strengthen the oversight and regulation of the shadow banking system with the aim of mitigating systemic risks, with particular attention to risks arising from banks’ interactions with shadow banking entities. The Basel Committee has chosen to address step-in risk because of its potential to erode a bank’s capital and liquidity position materially.
Based on comments and other input received on the December 2015 consultation,[1] the Committee has expanded the identification criteria to take into account the risk characteristics of the entities involved in addition to the banks’ relationships with them. Regarding a prudential response, the Committee has adopted a tailored rather than a standardized approach. To this end, the framework entails no automatic Pillar 1 capital or liquidity charge additional to the existing Basel standards. Rather, the framework supplements existing prudential measures to reflect step-in risk. Further, the Basel Committee is considering how the proposals should be incorporated into the regulatory framework and their potential effects.
The consultation has set a 60-day comment period with a focus on the supervisory reporting templates and any issues that require clarification. The Basel Committee indicated that it considers the revised framework as “near-final,” and does not envisage making significant changes. Comments on the proposal are due by Monday, May 15, 2017.
The consultation states that the present framework should enter into force as soon as possible and no later than the end of 2019. Further, the Basel Committee intends to monitor jurisdictions' progress in implementing the guidelines to keep itself informed of the approaches taken to identify step-in risk and the range of supervisory responses employed.
The full consultation document may be accessed via: http://www.bis.org/bcbs/publ/d398.pdf
[1] The Basel Committee’s first consultation on step-in risk was the subject of Fordham University’s and CSFME’s Regulatory Outreach for Student Education Winter 2016 Program. The Fordham scholars’ comment letters are available via: http://www.bis.org/bcbs/publ/comments/d349/fordham.pdf
CSFME submitted a comment letter of its own supporting generally the goals of the Basel Committee to minimize the potential systemic implications resulting from situations where banks may choose to provide financial support during periods of financial stress to entities beyond or in the absence of any contractual obligations. The Center expressed some concerns and offered some suggestions, however, regarding the approach taken by the Consultation. Furthermore, by offering an example from the trade finance sector, the Center supported its belief that the nature of step-in risk may be one example of an acceptable, non-diversifiable exposure, given the potential positives for the economy at large.