US Fed aims to adopt last Basel III part by January 2023 with 'capital neutral' calibrations across system

The US Federal Reserve will try to finalize the last phase of the Basel III capital reforms by January 2023 with new requirements to be calibrated for “capital neutrality” across the entire US banking system, a Fed official said.

“If we can’t find the right dials to turn inside the Basel III end-game risk-based reforms we’ll look at other parts of the capital framework" to ensure that it's "no more stringent than the capital framework we had before,” Fed General Counsel Mark Van Der Weide said at a webinar* yesterday.

He added: “If we need to tweak the [Global Systemically Important Banks] capital surcharge, if we need to tweak the stress capital buffer, that will be on the table.”

At the same time, the impact of the changes ”will vary substantially across different firms depending on their individual risk profiles,” Van Der Weide said. In general, he said, Basel will reduce US capital requirements for banks’ credit risk, while increasing them for operational and market risk.

Key issues

US banking regulators are grappling with some key issues as they prepare to issue a proposal this year for public comment, Van Der Weide said.

One issue is whether to impose capital requirements on small and mid-size banks after these rules are issued for large firms, he said.

Another question is the role that banks’ internal models should play in a regime required to have a largely standardized approach.

After final rules are adopted in 2023, the Fed intends to make sure banks “have a substantial amount of time” to build systems that comply with the requirements, he said.

Reaction

Jeremy Newell, a bank regulatory lawyer at Covington & Burling, called the final phase “sweeping” rather than just an application of finishing touches.

“It includes significant changes to nearly every important aspect of the Basel framework,” said Newell, who sat on the same panel as Van Der Weide. “Lots and lots of chess pieces are still on the table.”

He added that while the Fed intends the changes to be capital-neutral overall, “it’s absolutely certain there will be clear distributional effects whether you’re talking about individual firms or cohorts of firms.”

Firms with major trading operations are likely to be particularly affected “since trading operations are squarely in the bullseye” of the Basel changes, he said.

The Fundamental Review of the Trading Book, a Basel III standard intended to address firms’ capital requirements for wholesale trading, is one of the two most important rules due to be proposed, Fed Vice Chair for Supervision Randal Quarles said last week. The other relates to capital requirements for operational risk, or risk of loss from weak internal processes, people or systems, or due to external events.

Basel history

The initial phases of the 2010 Basel III accord, which was adopted in response to the global financial crisis, were implemented in the US in 2013. The final portion, or “end game,” was agreed to in 2017 by global authorities, though US implementation was delayed by the pandemic.

The end game seeks to give credibility to banks’ calculation of risk-weighted assets and improve the comparability of firms’ capital ratios.

It would phase in a standardized output floor for risk-weighted assets, calculated from standardized approaches, from 50 percent in 2022 to 72.5 percent in 2027. The final portion also would enhance the robustness and risk sensitivity of standardized approaches for credit and operational risk, which help make bank capital ratios more comparable.

*Bank Policy Institute and Securities Industry and Financial Markets Association “Prudential Regulation Conference”; June 2, 2021.