U.S. Banks and Basel III Endgame: Risk-Weighting Wars

Jesse Rosenthal – Head of U.S. Financials / Senior Analyst - Banks and Specialty Finance

  • U.S. bank regulators did their best Tolstoy impression, dropping a 1,000+ page tome covering the litany of Basel III endgame proposals. The document comes more than 5 years after the reforms were finalized by the Basel Committee; the Fed is accepting comments through November 2023, setting up potential finalization for next year.
  • Broadly speaking, the proposals would effectively do away with the existing advanced approach methodology, replacing it with a new “expanded risk-based approach” that includes standardized operational RWAs and revisions to the calculations for both market and credit RWAs. The ‘old’ standardized approach would still remain as part of the U.S.’ dual-requirement structure; the only aspect changing under the existing standardized approach is the market RWA methodology.
  • Estimated impacts are in-line with prior regulator commentary, namely a ~20% aggregate increase in RWAs with a commensurate impact on capital requirements. Also as expected, the largest banks are bearing the brunt of the increase with Category I & II banks seeing a ~24% aggregate increased compared to ~10% for the Category III and IV banks.
  • The introduction of standardized operational risk-weighted assets is doing most of the heavy lifting, accounting for nearly $2 trillion of the estimated RWA increase across the banks. The Fed proposal generally mirrors the Basel formula, including using fee income as a proxy with an add-on for operating losses incurred over a trailing 10-year period; importantly, the Fed proposes instituting a loss multiplier floor of 1x in what looks like another example of the gold plating approach.
  • Not in the least bit surprising, the Fed is also proposing to eliminate the AOCI opt-out for Category III and IV banks, a prime source of capital consternation this year—but subject to a protracted phase-in stretching all the way through the first half of 2028. Notably, the Fed did not tackle LTD/TLAC for regional banks in the long list of proposed reforms.

The much-anticipated and oft-delayed Basel III endgame reforms were finally proposed by U.S. bank regulators, bringing with it fairly significant changes in the regulatory framework that will raise capital requirements for the largest banks (>$100 bn in assets) via upward pressure on the denominator. Notably, this does not include the presumably pending regional bank TLAC/LTD proposal that Vice Chair Barr recently teased would be extended to include Category IV banks—we’re still waiting for that one.

The 1,000+ page Basel III endgame document includes a litany of proposed changes and we’re still digging through the details with follow-up pieces planned over the coming days and weeks (including a closer look at issuance implications from RWA inflation), but some of the highlights include:

  • Confirmation that the AOCI opt-out is going away for Category III and IV banks, albeit with a long phase-in period with a proposed effective date for full phase-in of mid-2028.
  • Effective elimination of the advanced approach methodology and use of internal modeling (except for market risk); banks will still be subject to dual-track capital requirements that preserves the Collins floor, but with the new “expanded risk-based approach” replacing the advanced while maintaining the old standardized approach with banks still required to be in compliance with the more onerous of the two capital frameworks.

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