Tuesday, May 30, 2017

Is Final Basel III Just Around the Corner?

"The output floor is the final piece of the jigsaw”

Author: David Schwartz J.D. CPA

In speeches on April 5 and May 25, 2017, William Coen, Secretary General of the Basel Committee, hinted that final Basel III standards are “just around the corner.” Despite a setback in January 2017 in which the Committee members could not reach accord on the calibration of the aggregate output floor, Coen signaled optimism for the upcoming meeting the Committee in June. In a May 25 speech, Coen announced that ‘based on feedback from the consultative process and the results of our impact studies, the Committee has largely completed the technical work needed to revise the framework.” Despite this optimism, calibration of the output floor still remains somewhat of a sticking point, one that Coen says “is the final piece of the jigsaw.”


The output floor is a result of a long process of consultation and revision. The design likely to be put forward for approval of the Basel Committee in June reflects a great deal of trial and error learning from this process to arrive at the output floor concept, Coen says. 


“[T]he Committee has reviewed and consulted on various ways of designing the output floor. This includes a very granular "exposure class/type" floor, based on individual exposures such as mortgages. We also considered a floor based on 'risk types' such as credit risk and market risk. In the end, the Committee has chosen the simplest form - an ‘aggregate' output floor. This is simple and straightforward - a bank's measure of risk-weighted assets (using internal models) can in aggregate be no lower than, say, 70-75% of the risk-weighted assets that would result if the bank had applied the standardised approaches to determine its risk-weighted assets."


The reason the output floor remains such a point of contention is its prospective effect is fairly widespread, with banks in some jurisdictions not yet fully prepared for these effects. To mitigate some of these effects, Coen says that he expects the Committee will address a phase-in process offering much deference to the timetables national supervisors.


"The calibration of the output floor is a difficult question because of concerns related to its impact. Even though the use of models for regulatory capital purposes related to credit risk has only been in place since around 2008 and despite the 80% floor that is part of the Basel II capital framework, the floor will likely have an impact on some banks. To acknowledge such differences in the readiness of banks across jurisdictions to meet new rules, the Committee has in the past allowed time for banks and supervisors to meet the implementation timelines, along with transitional arrangements to meet the new standards. Recall that in 2010, the Committee adopted 2019 as the date by which the Basel III requirements needed to be fully phased in. I suspect a similar approach will be taken for this set of revisions. Given the wide range of revisions, some time is needed to allow jurisdictions to conduct their legislative and rule-writing processes, and for banks to implement the changes in their systems and processes.


The Committee is also considering a reasonable phase-in for some elements of the revised standards. When it comes to the start date for the new rules and the adoption of any transitional and phase-in arrangements, it is important to note that these are solely at the discretion of the national supervisor. Early adoption of the rules is always an option.”


Implementation and Review


The Basel III framework has two goals: (1) ensuring minimum global standards of resilience so that banks are less likely to fail and (2) reducing the effect on the financial system and the economy when banks do fail. According to Coen, “full and consistent implementation of these standards within the internationally agreed time frame” is critical to achieving these goals. Through its Regulatory Consistency Assessment Programme (RCAP), the Committee has monitored the timely adoption of Basel standards by its member jurisdictions. RCAP has also conducted peer reviews on the "completeness and consistency of the standards adopted by member jurisdictions, including the significance of any deviations from the Basel framework.” Most importantly, however, RCAP also monitors the outcomes from adopting Basel III standards. In the course of the RCAP process, the Committee has used this process to calibrate regulatory capital ratios and arrive at the latest version of the output floor.


"The Committee has published five reports on the consistency of risk-weighted assets for similar assets in banks’ loan portfolios and trading books. These analyses confirmed that there are material variances in banks’ regulatory capital ratios that arise from factors other than differences in the riskiness of banks’ portfolios. This motivated the range of ongoing Basel III reforms aimed at reducing excessive variability of risk-weighted assets. These reforms include revisions aimed at enhancing the standardised approaches, constraining the discretion of internally modelled approaches and  complementing the risk-weighted framework with a robust leverage ratio and output floor.”


Mr. Coen said that the RCAP process, particularly monitoring outcomes and assessing calibration, will continue and remain a priority when the Committee does, at last, finalize Basel III.


"Implementation is a continuum and not a one-off event. To realise the full benefits, implementation requires a rigorous system of monitoring and analysis as well as a feedback loop to policy work.”


The full text of Mr. Coen’s recent speeches are available via: