Following the agreement between the EU Parliament, Commission and Council on 27 June 2023, nothing stands in the way of finalizing the Basel III requirements (also known as Basel IV). Implementation by the banks in the EU is expected to take place by 01.01.2025, so the time for implementation is running out.
What are the main changes and what impact will the implementation have on the banks?
With the introduction of Basel II, banks were able for the first time to reduce the regulatory capital ratio of 8% for their risks to an individual ratio based on an internal or external risk assessment. Particularly when using internal risk assessment (IRB), this can lead to a ratio of 1.6% at best. However, it is precisely this possibility that has led to the portfolio risks of individual banks no longer being comparable and the following problems becoming apparent:
- The capital requirements calculated by EU banks using internal models showed considerable fluctuations.
- Internal models can result in very different capital requirements for very similar or even identical exposures.
- Lack of risk sensitivity in the capital requirements calculated using standardized approaches
This results in the main changes for the calculation of risk capital:
- Strengthening the standardized approach for credit risks (SA-CR) in order to improve the robustness and risk sensitivity of the existing approach.
- Restriction of the use of IRB approaches for credit risks in order to reduce unjustified fluctuations in banks' RWA calculations.
- Replacing the existing Basel II output floor (OF) with a more risk-sensitive floor, reducing unwarranted variability in regulatory capital requirements due to internal models and enabling better comparability between standardized and IRB banks
The last point in particular will presumably lead to a higher capital requirement, with the Bundesbank assuming more than 10% in its model calculations. How can this be explained?
IRB banks must also assess their risks using an external rating from a recognized rating agency and report the risk capital (=RWA(Ex)) required as a result. The regulatory risk capital may not be less than the output floor* RWA(Ex), with the percentage for the output floor rising from 50% to 72.5% in 2030.
How can banks counteract this development?
There are 2 key steps here:
- Achieve transparency about the possible effects and create a "rating simulation" for the entire portfolio. This makes it possible to determine the "rateable" share and assess the potential impact. The result can also be used to select the rating agency, as higher rating shares (especially SMEs) presumably lead to an improvement.
- Improvements result in particular from the use of a rating for previously unrated portfolio components and the associated reduction of the risk weighting from 85% to the weighting corresponding to the risk class (between 20% and 150%)
According to a simulation we carried out on the basis of 8800 companies, the risk capital was reduced by 12%, whereby the improvement naturally depends on the portfolio quality of the respective bank.
The study was carried out by CRIF-Ratings. CRIF-Ratings is a rating agency recognized by the EBA and supervised by ESMA. It currently works with more than 80 banks throughout Europe and is characterized in particular by the rating of mid-cap and SME companies.
