Basel III: Endgame


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Pour one out for the weekends and Augusts ruined by the new bank-capital rules proposed by a trio of US regulators.

Wall Streeters and other analysts/lobbyists are piecing together the consequences of the thousand-plus-page proposal that constitutes the finale of the global regulatory response to the 2008-09 financial crisis.

Among the takeaways from the proposed rules, according to sellside notes:

  • There could be an approximately 24-per-cent increase in risk-weighted assets for the largest banks (with more than $750bn in assets), and 11 per cent for banks with more than $100bn. This affects basic calculations of capital requirements, because regulators measure bank capital as a proportion of risk-weighted assets.

  • The standardisation of “operational RWAs” — in the past the biggest banks had the option of calculating operational risk with internal models. This takes away that option in favour of more standard metrics.

  • Regulators also want to include cross-jurisdictional derivatives claims in their calculations of capital requirements at global systemically important banks, or G-SIBs.

  • Banks with more than $100bn in assets will need to include accumulated other comprehensive income, or AOCI, in regulatory capital calculations, though only starting in 2028. This means some banks with unrealised losses in their available-for-sale bond portfolios will now need to hold capital against losses.

Most bankers expected tougher capital requirements. The Basel standards are a global effort, at least in theory, and the US’s proposals lag behind EU’s Basel Endgame rules. And past comments from Federal Reserve Vice Chair Michael Barr highlighted the Fed’s commitment to shoring up capital requirements. In any event, the US isn’t uniquely preoccupied with bank capital; CreditSights says this fits with American regulators’ usual approach to regulation, which is to “gold plate” rules first adopted internationally.

Even so, the timeline is a bit quicker than Goldman Sachs’ bank-equity analysts expected, and the capital requirements a bit stricter. They wrote that “the phase-in period looks to be more onerous than we had anticipated, with banks required to reach 80-per-cent compliance with B3E RWA changes by [July 1 2025].”

The bank’s analysts found that the new proposal could translate into a capital deficit of 20bp, or $15bn, if implemented right away. (NB: this does not include GS.)

The analysts also point out a different rule proposal for changing the extra capital-buffer requirements imposed on G-SIBs. Along with the inclusion of derivatives in the G-SIBanks’ cross-jurisdictional capital requirement calculations, “they are also adding in a broader range of non-bank financials in the intra-financial system calculations, such as PE firms, asset managers and exchange traded funds,” writes GS.

This could be interesting for banks’ prime brokerage businesses, which have been notably steady as of late. The analysts estimate that the capital “buffers” required would increase 20bp at Bank of America and State Street, and 10bp at JPMorgan and Wells Fargo. (Again, they do not include their own prime-brokerage-standout bank in this analysis.)

Still, the inclusion of operational RWAs is likely the biggest change, and possibly the largest burden, on US banks from the Basel III Endgame rules, CreditSights analysts say.

The proposed rules say these RWAs will be based on data meant to measure the volume and complexity of a particular bank’s business. These will be based on lease/interest/dividend-producing activities; services such as fee/commission income; and financial and/or trading activities.

CreditSights highlights that American Express could see an outsized impact on capital requirements, because of its reliance on fees for income:

Among the bigger banks, Morgan Stanley is expected to see the largest relative increase in capital requirements from these changes, according to CreditSights and GS. But CreditSights analysts argue that other changes to the systemic-risk calculations (which are compared to risk-weighted assets) could lead Morgan Stanley to drop a G-SIB size category, simply because their RWA base will be larger.

On the bright side for US banks, they are ahead of the game in holding capital against their credit risk. In fact, CreditSights found that risk-weighted asset measurements for credit should actually decline.

Goldman Sachs’ credit strategists, for their part, say that the agency mortgage-backed securities market could incrementally benefit from the treatment of MBS under the new rules:

The notice of proposed rulemaking (NPR) leaves agency MBS generally untouched from a risk weighting perspective. As a result, we expect this to be a marginal positive for the GNMA MBS basis, as banks may seek out more capital-efficient instruments over time. This is especially the case since the Ginnie/Fannie swap is cheap relative to history (Exhibit 1 and 2). We note that this view is longer-term and will take time to realise given the tenor of implementation.

Another question raised by all of this is what the banks will do in response. It isn’t clear how that will work just yet. As GS’s equity analysts point out, this doesn’t necessarily mean that the biggest banks will need to sell equity or issue debt to raise capital:

We take no view on the magnitude of banks’ RWA mitigation: Banks have historically been able to reduce RWA increases from regulatory capital rule changes as they adapt to new standards, and we expect this to occur with the Basel III Endgame, although it is difficult to estimate the amount of RWA mitigation without knowing which businesses will be most impacted.

Plus ça change, plus c’est la même chose.

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