Andrea Cremonino (Jan 25)
The BTRM Newsletter: BTRM Faculty Opinion
Basel IV impacts and how banks can manage them – Andrea Cremonino, BTRM Faculty [1]
This article aims to outline what are the impacts for banks further to the forthcoming Basel IV regulation and how financial institutions could manage them.
To this purpose, firstly we describe the main innovation of Basel IV, then the impacts on banks and then the implementation strategies with an example of interbank lending.
1. Main innovation of Basel IV and impacts on banks.
Basel IV is the nickname for the completion of the innovation to the so called “Basel III” package aiming to further strengthen the banks against future financial turbolences. It is known as Basel III Endgame in the US, Basel 3.1 in the UK while in the European Union is embodied in the Capital Requirement Directive VI and the related Capital Requirements Regulation (CRR3).
The initial timeline set by the Basel Committee has been adapted by each jurisdiction: European Union and UK in 2025 while many countries have already implemented Basel IV, e.g. Australia and Canada in 2023, Japan and Singapore in 2024.
For US, as per January 2025 no clear deadline is set, also further to some banks sued FED about Basel III enforcement.
The goal of strengthening banks’ resilience is achieved by increasing capital requirements via higher RWAs. To this purpose the main changes of Basel IV could be summarised as follows:
- narrowing the scope of internal models for credit, market and operational risks;
- making the standard approach more risk sensitive;
- introducing an output floor, i.e. RWAs calculated with internal models should be higher than 72.5% of those according to standard approach.
On the other hand, it should be considered that further increase of capital buffers could lead to a decrease of credit supply.
2. Impacts on Banks
Basel IV impacts vary between geographies, bank types and business models. As a matter of fact, implementation is uneven for regulators introducing extra rules or applying a two-track system for banks that are subject to higher standards, especially in the Asia-Pacific region and US.
Also, business model will play a key role in setting the impacts magnitude, where banks with more traditional lending activities are expected to suffer from the major regulatory impacts.
The consequences on banks at a global level could be gauged thanks to the impact studies performed by the Basel Committee with the last one released in October 2024 related to full year 2023 data[2]. It is based on 180 banks, including 118 banks that have Tier 1 capital of more than €3 billion and are internationally active (Group 1) and other 62 ones (Group 2).
Overall capital requirements are to grow, with the average impact of the Basel III framework on the Tier 1 minimum required capital (MRC) of Group 1 banks (+1.3%), albeit lower than the survey at end-June 2023.
As expected, impacts for Group 1 banks across regions vary considerably as summarised in the table below.
Such conclusions are broadly confirmed by the survey run by the European Banking Authority (EBA)[3] on 152 European banking group.
3. How banks can mitigate impacts
To implement Basel IV and safeguard profitability, banks must face the challenges related to
- Operations, mainly due to run two parallel RWA calculations;
- Strategy, i.e. how to ensure proper capital remuneration.
A proposed framework to deal with strategy is structured on three steps as represented in the picture below:
- First: reassess the RWA related to each business line with the best option at single product level. In some cases, such as for some mortgage clusters, new RWAs could turn out to be lower while in most cases they are expected to be higher than the current ones.
- Second: recalculate the business line/ product risk adjusted profitability according to reassessed RWAs
- Third: rethink the business model to focus on the most profitable segments
An example of such framework is reassessing interbanking loans because under the current regulation, exposures to banks without a rating by an entitled rating agency have a risk weight of 20%, 50%, 100% or 150% according to the rating of their country.
Under Basel IV, such exposures would be classified in three clusters with risk weights respectively 40%, 75% e 150%.
However, exposures to unrated banks with an original effective maturity up to three months retain 20 % risk weight as the previous regime.
Such changes imply capital requirements for most exposures to banks could increase therefore worsening the risk-adjusted profitability.
That would trigger banks to review the business strategy for such business via the following levers:
- Decrease exposure to some banks;
- Reprice some exposure;
- Shorten the exposure tenor to three months or less.
Such changes are posed to impact also the banks’ funding strategy as banks with an higher risk weight could face either lower borrowing or price increase or both.
[1] The opinions expressed here belong to the Author and do not reflect the views of any of his affiliations.
[2] Basel Committee on Banking Supervision: “Basel III Monitoring Report”, October 2024. Document d581.