Basel III Endgame PDF: A Comprehensive Guide to the Changes

The Basel III Endgame PDF is a comprehensive guide to the changes brought about by the Basel III accord. The accord aims to strengthen the regulation of banks and improve their resilience to financial shocks.

One of the key changes is the introduction of a 7% Common Equity Tier 1 (CET1) capital requirement, which is a significant increase from the previous 4% requirement. This will require banks to hold more capital against their assets.

Banks will also be required to maintain a leverage ratio of 4%, which means they will need to ensure that their capital is sufficient to cover a certain percentage of their assets. This will help to prevent banks from taking on too much debt.

The implementation of these changes will be phased in over several years, with the final deadline being January 1, 2019.

Broaden your view: Third Basel Accord

The Basel III Endgame proposal aims to strengthen bank regulation, supervision, and risk management.

The proposal includes changes to bank capital rules, which would apply the Tailoring Rule to Category I – IV banking institutions. This rule reflects the relative risk and complexity, as well as systemic risk, of large versus smaller banks.

The proposal may exempt Category III firms (those with assets between $250 and $700 billion) from market risk and CVA capital changes unless they engage in significant trading activity. It may also revert to the simpler, current definition of capital for these firms.

Category IV firms (those with assets between $100 and $250 billion) may be exempt from the credit risk and operational risk frameworks, as well as market risk and CVA, unless they engage in significant trading activity.

The proposal also includes changes to credit risk, operational risk, and market risk. Highlights of the potential changes include reducing risk weights for residential real estate and retail exposures, extending reduced risk weight for low-risk corporate debt, and eliminating the minimum haircut for securities financing transactions.

The Federal Reserve, along with the FDIC and OCC, released their proposal to implement the final Basel III reforms in the United States in July 2023. The proposal seeks to apply a broader and more conservative regime of capital requirements than the Basel Committee suggested.

Banks with assets exceeding $100 billion could face a substantial increase in required capital holding requirements under the proposal. Estimates for domestic non-GSIBs are generally 16-20%, while the U.S. GSIBs estimate the proposal will increase their capital requirements by roughly 30%.

For another approach, see: Basel 4

The Basel III Endgame Proposal has significant implications for foreign banks, particularly those in Category II. The Fed and FDIC issued resolution planning guidance in 2020 that outlined increased capability requirements.

These incremental requirements are more onerous than those applicable to Category III and Category IV foreign banks. Existing Category II foreign banks have aligned to these expectations over multiple years.

Capital and liquidity projection requirements are just one aspect of the increased resolution planning requirements. Governance playbooks, operational capabilities, and legal entity rationalization are also key components.

Derivatives and trading practices are another area where Category II foreign banks must demonstrate increased capability. This includes meeting the expectations outlined in the 2020 resolution planning guidance.

Suggestion: Basel II

The Basel III Endgame proposal aims to strengthen the regulation, supervision, and risk management of banks. The proposal was released by the Federal Reserve, OCC, and FDIC in July 2023, and it's a response to the global financial crisis of 2007-09.

The proposal focuses on the amount of capital that banks must have against the credit, operational, and market riskiness of their business. Regulators say the net effect of the proposal would be to increase the required highest-grade capital by about 16% on average.

The proposal would apply the stiffest risk-based capital approach to more banks, those with $100 billion or more of assets, up from the current threshold of $700 billion. This means that 37 large banks in the U.S. would be covered, holding more than three-quarters of all bank assets in the U.S.

Community banks and smaller regional banks wouldn't be affected by the proposal. The regulators would require banks to have more capital for risks posed by trading activities and by operations, and to use standard models instead of internal ones to gauge these risks.

The proposal would also require banks to reflect in their capital calculations any gains and losses in portfolios deemed "available for sale", as opposed to securities the bank plans to hold until maturity. This change would impact banks with assets of $100 billion or more.

Here are some of the key changes proposed in the Basel III Endgame:

The proposal has received significant opposition from economists, advocates, and industry leaders, who argue that the rules could increase the cost and decrease the availability of credit and other financial services. The regulating agencies accepted public comments on the proposal until January 16th, 2024, and must now consider the public comments and work towards developing a final set of rules.

The Basel III endgame proposal has significant operational implications for banks. The proposal would introduce a new operational risk capital charge for all banks, regardless of their current approach.

The operational risk RWA under the proposed expanded risk-based approach would increase by $2 trillion, with Category I and II banks experiencing 78% RWA inflation, and Category III and IV banks facing 118% total RWA inflation compared to the current standardized approach.

The proposal also introduces a new framework for calculating operational risk, which would be a major undertaking for banks. Implementing Basel III endgame would require large-scale efforts and coordination between functions, including stress testing, SCB volatility in the phase-in, governance, and data.

The operational risk RWA would become a capital charge on size alone for firms with limited operational risk loss histories, which has substantial overlap with the G-SIB surcharge. This could lead to increased capital requirements for larger banks.

For another approach, see: Basel Iii Endgame Summary

Here are some of the key implementation challenges:

The new operational risk framework would also introduce a penalty for firms with high historical operational losses, which could lead to increased capital requirements for banks with a history of operational risk issues.

Market risk RWA would rise by approximately 75% across all banks due to the proposal's expanded scope to all Category I through IV banks. This expansion includes banks that were already captured by the current market risk scope, as well as an additional 10 banks that would be included due to the new Category I through IV bank requirements.

The proposal introduces a new framework for standardized market risk capital that all in-scope firms will need to implement, which is expected to result in higher market risk capital requirements. This new framework requires desk-level application and ongoing monitoring for internal model approach (IMA) trading desks.

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Here are some key points to note about the market risk changes:

G-SIB surcharges are expected to rise, further driving firms to re-evaluate their business strategies in light of incremental capital burdens. The Fed's proposed amendments to the G-SIB surcharge methodology and Systemic Risk Report (FR Y-15) would increase capital requirements for G-SIBs.

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G-SIB surcharges are expected to rise, driven by the inclusion of derivatives in cross-jurisdictional claims and liabilities. This change will increase the capital requirements for Global Systemically Important Banks (G-SIBs).

The regulators predict an average increase of 13 basis points across G-SIBs, with an estimated overall increase of $13 billion in risk-based capital. This means that G-SIBs will have to hold more capital to cover potential risks.

The proposed changes include shifting from end-of-period values to averages, which will require more data. This change aims to reduce cliff effects, where banks are suddenly required to hold more capital due to a change in their risk profile.

Here are the key changes to G-SIB surcharges:

These changes will further drive firms to re-evaluate their business strategies in light of incremental capital burdens and operational complexity.

The proposal expands the market risk RWA requirements to all Category I through IV banks, which is estimated to include an additional 10 banks that weren't previously captured.

Many of these banks were already included in the current market risk scope, which applies to those with aggregate trading assets and liabilities over $1 billion or 10% of total assets.

The new requirements will bring a handful of banks outside of Category I through IV under the market risk capital RWA, but only if their aggregate trading assets and liabilities exceed $5 billion.

The United States is the only jurisdiction that has a stress capital buffer (SCB) calculated as a function of supervisory-run capital stress testing models. This unique approach means that banks are already holding capital for operational risk due to the Fed's stress test models projecting around $200 billion of operational risk losses.

Banks participating in the stress tests are already holding capital for operational risk, which would be doubled if the proposed changes to operational risk RWA calculation are implemented. This could have significant implications for banks' capital requirements.

A different take: Basel 4 Impact on Banks

Banks will need to calculate capital under two approaches: the Standardized Approach (SA) and the expanded risk-based approach. The SA remains largely unchanged, except for some adjustments to market risk and derivatives exposures.

The expanded risk-based approach will introduce a new method of assigning credit risk and operational risk, and will generally increase the riskiness assigned to certain types of assets. This approach will also limit banks' ability to use their own internal risk models to determine the riskiness of their lending activity.

Banks with assets exceeding $100 billion could face a substantial increase in required capital holding requirements under the proposed rules. Estimates suggest that domestic non-GSIBs could face increases of 16-20%, while U.S. GSIBs estimate the proposal will increase their capital requirements by roughly 30%.

Here is a summary of the new requirements and approaches:

The new requirements and approaches are quite complex, but let's break down the key information.

Banks with assets exceeding $100 billion could face a significant increase in required capital holding requirements under the proposal.

The proposal is often referred to as the "Basel III Endgame" and was released by the Federal Reserve, FDIC, and OCC in July 2023.

Estimates suggest that domestic non-GSIBs will face a 16-20% increase in capital requirements, while U.S. GSIBs estimate a 30% increase.

The increased capital requirements can vary substantially by firm depending on their business model.

The Federal Reserve and other agencies believe most banks can adjust to the additional capital requirements without much difficulty.

However, critics argue that the new rules will impose a significant cost on lenders and have criticized the agencies for failing to include meaningful data or analysis.

Public comments on the proposal were accepted until January 16th, 2024, and overwhelmingly opposed the proposal in its current form.

The agencies must now consider the public comments and work towards developing a final set of rules.

Covered financial services organizations will need to begin transitioning to the new framework by July 1st, 2025, with full compliance by July 15th, 2028.

Stress testing would use the enhanced risk-based approach. This means banks would need to project capital ratios under their company-run stress test and under the baseline scenario.

For Category I-III banks, this would involve projecting capital ratios under their company-run stress test. The binding constraint for most banks would likely be the expanded approach.

Banks would need to enhance their stress testing systems to apply the new RWA rules. This includes adding granularity to existing models to support new calculation requirements.

Banks would need to project the distribution of transactor and revolvers for credit card exposures. This is one of the new calculation requirements that banks would need to support.

The new approach would require banks to project the distribution of investment grade and non-investment grade corporate loans. This would add an extra layer of complexity to their stress testing systems.

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The proposal introduces two new approaches for credit valuation adjustment (CVA) to replace the current methods for over-the-counter derivatives (OTC) counterparty credit risk exposures.

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The Basic Approach (BA-CVA) applies standardized formulas with supervisory risk weights based on the sector of each counterparty to the exposures at default for covered derivatives positions.

The Standardized Approach (SA-CVA) applies a risk sensitivity-based approach similar to the market risk SA methodology, but with less granular risk factors and risk buckets.

Here are the key differences between the two approaches:

Banks would be required to meet additional criteria for SA-CVA, making it a more complex approach than BA-CVA.

The Basel III Endgame is the final set of rules developed by the Basel Committee to strengthen the regulation, supervision, and risk management of banks. These rules focus on the amount of capital banks must have against the credit, operational, and market riskiness of their business.

The new rules will require banks to hold more capital for certain types of lending, such as trading, market-making, wealth management, and investment banking. This means banks with large operations in these areas will be hit harder than those with more traditional lending models.

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Banks will also have to set aside more capital for mortgages, particularly those with high loan-to-value ratios. In fact, the risk weights assigned to some mortgages in the proposal exceed those in the Basel Committee standards.

The proposal also introduces a new non-risk-based leverage ratio to serve as a backstop to the risk-based capital requirements. This means qualifying banks must hold a Common Equity Tier 1 (CET1) Capital buffer of 50% of their overall risk-weighted capital.

Here's a breakdown of the two new approaches for credit valuation adjustment (CVA):

All large banks will use the standardized approach for counterparty credit risk (SA-CCR), which will add significant implementation complexity. This means Category III and IV banks will no longer have the option to use the current exposure method (CEM).

Dual calculations will be required, with banks needing to calculate RWA under both the SA and the expanded risk-based approach. The SA remains largely unchanged except that all large banks must use the revised framework for market risk and Category III and IV must use SA-CCR for derivatives exposures.

Banks will need to conduct a thorough inventory assessment of potential covered and excluded positions and hedges recognized through internal risk transfers to identify their market risk RWA exposure.

The proposal provides revised definitions of covered market risk positions with explicit inclusion of unrestricted, publicly-traded equity positions.

Banks would need to specify the eligibility requirements for internal risk transfers between a banking unit and a trading desk.

Classification of positions within the banking or trading book effectively cements the capital treatment of such positions, as subsequent recategorization would trigger a compensatory capital add-on to offset any potential capital benefit that may appear to arise.

Debt securities for which the fair value option was elected and associated hedges would be excluded from the revised definitions of covered market risk positions.

If this caught your attention, see: Basel Committee on Banking Supervision

Specific changes and exemptions are likely to have a significant impact on the banking industry under Basel III. G-SIB surcharges are expected to rise, increasing capital requirements for systemically important banks.

The Fed has proposed amendments to the G-SIB surcharge methodology that would shift to averages from end-of-period values, increasing data requirements. This change aims to reduce cliff effects, but will also add operational and compliance complexity.

Seven foreign banks and two intermediate holding companies would be elevated to Category II, imposing higher risk management and capital requirements. Higher liquidity and capital requirements will also be necessary, along with increased resolution planning requirements.

Here are the key changes in a summary:

G-SIB surcharges are expected to rise, driven by changes to the methodology and Systemic Risk Report (FR Y-15). The proposed amendments would increase capital requirements for G-SIBs, making them re-evaluate their business strategies.

The regulators predict an increase of 13 basis points on average across G-SIBs, with an overall estimated increase of $13 billion in risk-based capital. This change is a result of including derivatives in the cross-jurisdictional claims and liabilities.

The changes would also shift to averages from end-of-period values and increase data requirements, reducing cliff effects. This means that G-SIBs would need to provide more frequent and detailed data to calculate their systemic risk profile.

Here's a breakdown of the expected changes:

These changes aim to improve the calculation of the capital surcharges for G-SIBs by reflecting changes in the global banking system since 2015.

Foreign entities are in for a change, as several foreign banks would be elevated to Category II. This shift would affect seven foreign banks and two intermediate holding companies (IHCs).

These entities would move from Category III or IV to Category II, creating substantial new liquidity and resolution planning requirements. This would be difficult and costly to implement.

Higher risk management and capital requirements would be imposed on these foreign banks, making it essential for them to reassess their business strategies. They would need to account for the increased capital burdens and operational complexities.

Higher liquidity and capital requirements would also be imposed on the two IHCs moving to Category II. They would need to implement reliable, daily FR 2052a reporting to the Fed, a major challenge for banking institutions.

The IHCs would also be subject to additional capital requirements, including annual company-run stress testing. This would require significant investment in data and reporting systems.

Here are the specific requirements for foreign banks and IHCs moving to Category II:

These changes would have a significant impact on foreign banks and IHCs, requiring them to adapt to new regulatory requirements. It's essential for them to closely evaluate the updated measurement and reporting changes and the impact of becoming subject to Category II requirements.

The removal of non-significant equity investments (NSEI) for individual equity exposures would have a significant impact on risk-weighted assets. This change would eliminate the preferential risk weight of 100% for equity exposures up to 10% of a bank's total capital.

Under the current simple risk-weight approach (SRWA), equity exposures within this range would be assigned a risk weight of either 250% for public equity or 400% for private equity. This is a material change from the current U.S. rules.

For another approach, see: Basics of Equity Market Pdf

The removal of the opt-out from AOCI is a significant change for certain banks.

Category III and IV banks will no longer be able to opt-out of recognizing unrealized gains and losses on available-for-sale securities.

This means unrealized gains will increase capital levels, whereas unrealized losses will decrease them.

As a result, banks will need to include these gains and losses in their regulatory capital calculations, which could impact their overall financial stability.

The removal of the opt-out from AOCI is a change that will affect banks' financial reporting and regulatory compliance.

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Category III and IV banks are required to deduct mortgage servicing assets and other threshold items that exceed 25% of their common equity tier 1 (CET1) capital.

This is a significant change, as previously these banks only had to deduct threshold items that exceeded 25% of their CET1. The new proposal would subject them to the more punitive deduction requirements of Category I and II banks.

Category III and IV banks would also be required to deduct significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock, and non-significant investments in the capital of unconsolidated financial institutions.

These changes would increase these banks' CET1 deductions and reduce their available CET1 capital.

The output floor is unlikely to be a significant constraint for most banks in the US. This is because the output floor is set at the same level as in the Basel framework, but the US only allows the use of the Internal Models Approach (IMA) under market risk, whereas the Basel framework allows its usage under all risk stripes.

The Collins Amendment requires that "generally applicable" risk-based capital requirements serve as a floor for banking institutions' regulatory capital. This means that the capital requirements calculated under the Standardized Approach (SA) will serve as the mandated floor.

Banks in the US will likely find that the output floor is irrelevant to their capital calculations. The limited scope of the IMA's use in the US reduces the potential impact of the output floor.

Implementing the Basel III Endgame requires significant efforts and coordination between functions.

Stress testing would use the enhanced risk-based approach, which is a new calculation method that banks need to apply. This approach would require banks to project capital ratios under their company-run stress test and under the baseline scenario.

Banks would need to enhance their stress testing systems to apply the new RWA (Risk-Weighted Assets) rules and add granularity to existing models.

The proposal adds completely new calculations and requirements, making it a large-scale effort.

Here are some key areas that would require attention:

Banks would be required to project the distribution of transactor and revolvers for credit card exposures, and the distribution of investment grade and non-investment grade corporate loans. This would require banks to add granularity to their existing models and apply the new RWA rules.

The Basel III endgame has significant regulatory and economic impacts.

The Basel III accord introduces stricter capital and liquidity requirements for banks, which can lead to increased costs and reduced lending capacity.

Banks will need to hold a minimum Common Equity Tier 1 (CET1) capital ratio of 4.5% to 5.5% of risk-weighted assets.

This can result in reduced bank profitability and potentially even bank failures, especially for smaller banks with lower capital buffers.

The accord also introduces a leverage ratio of 3% to 4% of total assets, which can further restrict bank lending.

The increased regulatory burden can lead to a credit crunch, as banks become more cautious in their lending practices.

The Basel III endgame is expected to have a significant impact on the global banking system, with some estimates suggesting that up to 20% of banks may fail to meet the new capital requirements.

For another approach, see: Bank Statements Pdf

The regulatory proposals surrounding Basel III Endgame have been met with a mix of support and opposition.

The Federal Reserve, FDIC, and OCC released a proposal in July 2023 to implement the final Basel III reforms in the United States. The proposal aims to apply a broader and more conservative regime of capital requirements than the Basel Committee suggested.

Regulators say the net effect of the proposal would be to increase the required highest-grade capital by about 16% on average, with a bigger increase imposed on the biggest banks. This could result in the largest banks having to hold an additional 2 percentage points of capital, or an additional $2 of capital for every $100 of risk-weighted assets.

The proposal has been criticized for failing to include meaningful data or analysis to demonstrate that the expected benefits of such an increase justify the significant cost. The regulators accepted public comments on the proposal until January 16th, 2024, and the comments overwhelmingly opposed the proposal in its current form.

Here are some of the key changes proposed in the Basel III Endgame:

The agencies must now consider the public comments and work towards developing a final set of rules, with covered financial services organizations needing to begin transitioning to the new framework in its final form by July 1st, 2025, and full compliance by July 15th, 2028.

The U.S. regulator proposals have been making headlines lately, and it's worth taking a closer look at what's being proposed. The Federal Reserve, along with the FDIC and OCC, released a proposal to implement the final Basel III reforms in the United States in July 2023.

The proposal, often referred to as "Basel III Endgame", aims to apply a broader and more conservative regime of capital requirements than the Basel Committee suggested. This is in response to the turmoil in the spring of 2023 and the collapses of Silicon Valley Bank and First Republic Bank.

Banks with assets exceeding $100 billion could face a substantial increase in required capital holding requirements under the proposal. Estimates for domestic non-GSIBs are generally 16-20%, while the U.S. GSIBs estimate the proposal will increase their capital requirements by roughly 30%.

The regulators believe most banks could adjust to any needed additional capital under the proposed requirements without much difficulty. However, some economists and advocates insist these new rules will impose a significant cost on lenders and have widely criticized the agencies for failing to include any meaningful data or analysis to demonstrate that the expected benefits of such an increase justify the significant cost.

The proposal would change both the numerator and the denominator in the capital/risk-weighted assets calculation. The largest banks would have to hold an additional 2 percentage points of capital, or an additional $2 of capital for every $100 of risk-weighted assets.

Some of the major changes proposed by regulators include:

The regulators accepted public comments on the proposal until January 16th, 2024. Comments overwhelmingly opposed the proposal in its current form and recommended either substantial revisions or that the agencies rescind the proposal and re-propose new rules supported by available data.

The proposal to implement stricter regulations on businesses has sparked intense debate, with several arguments against it emerging. One major concern is the potential for increased costs, which could lead to job losses and economic instability, as seen in the example of the small business that was forced to lay off employees due to a similar regulatory overhaul.

Some critics argue that the proposed regulations are overly broad and could stifle innovation, as illustrated by the case study of a startup that was unable to operate due to excessive red tape.

The proposal's emphasis on paperwork and reporting requirements has also raised concerns about the burden on small businesses, which may not have the resources to comply with the new regulations.

Critics argue that the proposed regulations are not tailored to the specific needs of different industries, and could have unintended consequences, such as driving businesses underground or forcing them to relocate.

The proposal's focus on increasing transparency and accountability has also been questioned, with some arguing that it could lead to a culture of fear and mistrust, as seen in the example of a whistleblower who was penalized for speaking out against a company.

Some argue that the proposed regulations are not evidence-based and are instead driven by ideology, which could lead to ineffective and inefficient policies.

The Basel III Endgame is the final set of rules developed by the Basel Committee to strengthen the regulation, supervision, and risk management of banks. These rules focus on the amount of capital that banks must have against the credit, operational, and market riskiness of their business.

The Basel III Endgame is intended to improve international comparability among financial institutions and ensure banks' capital ratios are transparent and their risk-weighting calculations are credible. The rules aim to strengthen the regulation, supervision, and risk management of banks.

The Basel III Endgame includes changes to bank capital rules in the U.S. that are intended to be aligned with the Basel III standards. The proposed changes would apply the "Tailoring Rule" to Category I-IV banking institutions, which reflects the relative risk and complexity, and systemic risk, of large versus smaller banks.

Here are some of the key changes proposed in the Basel III Endgame:

The Basel III Endgame also includes changes to credit risk, operational risk, and market risk. Some of the highlights of the potential changes include reducing risk weights for residential real estate and retail exposures, eliminating the minimum haircut for securities financing transactions, and introducing a multiyear implementation period for the profit and loss attribution tests.

Basel III is a set of measures developed by the Basel Committee in the years following the global financial crisis of 2007-09.

These measures aim to strengthen the regulation, supervision, and risk management of banks, with a focus on the amount of capital that banks must have against the credit, operational, and market riskiness of their business.

The final set of rules has been dubbed the “Basel III Endgame.”

In July 2023, the Fed, OCC, and FDIC published for comment proposed changes to bank capital rules in the U.S. that are intended to be aligned with the Basel III standards.

The Basel Committee released a revised package of reforms in December 2017, often referred to as “Basel 3.5” or “Basel IV” in international jurisdictions.

This revised package was intended to improve international comparability among financial institutions and ensure banks’ capital ratios are transparent and their risk-weighting calculations are credible.

The 2017 proposal revised and expanded the current use of “standardized approaches” to calculating a firm’s risk-weighted assets (RWAs).

The proposal introduced increased minimum capital requirements and a new non-risk-based leverage ratio to serve as a backstop to the risk-based capital requirements.

Qualifying banks must hold a Common Equity Tier 1 (CET1) Capital buffer of 50% of their overall risk-weighted capital.

Most banks with $100 billion or more in assets are currently required to hold a minimum CET1 ratio of at least 8%.

The initial timeline mandated member states implement the new rules by January 2022, but following delays during the COVID-19 pandemic, most member states are on track to implement their versions of the new rules by July 2025.

The current situation surrounding Basel III Endgame is quite complex and contentious. National banking trade associations, large lenders, and industry advocates are expressing alarm at the U.S. proposal.

Many experts, including the Brookings Institute, have raised concerns about the lack of economic data and analysis supporting the suggested changes. This lack of analysis is causing unintended consequences on economic growth and consumers.

The collapse of Silicon Valley Bank (SVB) in 2023 has led some to suggest a more aggressive approach, but postmortem analyses show that the SVB collapse was a traditional bank run, not a system-wide problem.

U.S. banks have survived the COVID-19 pandemic without collapse, and no major institution has failed the Fed's stress tests in years, indicating that U.S. banks are well-capitalized.