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Navigating the Finalisation of Basel III

As the Finalisation of Basel III moves closer, banks must make shifts to prepare assets and capital to meet new regulations. For many, the January 1, 2023, deadline is rapidly approaching, with much left to be done – especially as we shift assets and focus to economic recovery (post) pandemic. Basel III changes are extensive, but, according to a new EBA report, of minimal impact in terms of immediate changes to MCR. However, with significant changes to models, new risk calculations must be handled with care.

Basel III introduces significant changes to MCR (13.7%) by increasing credit risk and output floor requirements. This aligns with new liquidity (LCR) requirements, which require a 1-month buffer of high-quality liquid assets. For example, the EBA report suggests EU banks require €3.1 billion in additional Tier 1 capital to comply. This increase is slightly offset by other changes, such as the impact of leverage ratio, which is less constraining in the new Basel III framework.

Basel III’s Significant Impact

The first of these implications is the need to align taxonomies and definitions. This adjustment means moving SA in line with A-IRB, significantly revising scope and impacting collateral by introducing different eligibility criteria.

Asset categorization is further complicated by the introduction of new asset classes, including existing classes which have been split. These criteria reflect new definitions and present a challenge for financial organizations wishing to reclassify assets to optimise capital values, to maintain IRB collateral, or to revise the eligibility of using the IRB approach for those classes.

The second major consideration is AMA being phased out in favour of a standardised measurement approach (SMA) for Pillar 1 capital. Financial organizations currently relying on AMA will have to assess whether to phase out existing operational risk models, to keep running AMA and instead report outputs as Pillar 2, or to repurpose existing AMA models. For most, it will mean revisiting the full operational risk model to recalculate using the SMA.

Output floor changes, which mandate that internal model calculations cannot fall below 72.5% of the SA, also limit how capital can be presented. However, with most impacts starting after 2026 – this is less of an immediate concern.

Capital requirements are also somewhat offset by Basel III’s new leverage ratio minimums, which require dividing Tier 1 capital by average total consolidated assets, with a minimum ratio to be maintained in excess of 3%, or higher for some organizations.

Moving Forward with Basel III

Eventually, meeting Basel III requirements means creating new calculations and new reports, or adjusting existing reports to reflect the new calculations, with complex considerations and decisions to be made.

That’s further complicated by Basel III’s capital requirements, which could represent a significant blocker to efforts for economic recovery. However, as the EBA report shows, the highest impacts to capital occur in 2026, with further strong increases in 2027, and 2028. With careful planning, that, in combination with the year of delay, could potentially provide a much-needed buffer.

Navigating these changes, while steering risk models in a direction beneficial to your unique financial organization, requires planning and good analysis. At Ace, we can help you to consider all aspects of the choices ahead, paying attention to all facets and disciplines within your company, as well as any co-dependencies you might have, to ensure you’re using the most beneficial models as you move forward.

If you want to talk, or have further questions about the finalisation of Basel III, feel free to get in touch.

As always, thanks for reading,