28 January 2021

ECON Brief: Banking Union: Postponed Basel III reforms

This briefing summarises the Basel Committee’s decision to postpone the implementation of the outstanding Basel III standards, their main content, and their estimated impact on banks’ capital needs.

Basel Committee postponing the Basel III reforms

On 27 March 2020, the Basel Committee's oversight body, the Group of Central Bank Governors and Heads of Supervision, responded to the challenges of the Covid-19 crisis and endorsed changes to the implementation timeline of the outstanding Basel III standards:
• The implementation date of the Basel III standards finalised in December 2017 was deferred by one year to 1/1/2023, which also affects the transitional arrangements for the output floor, deferred to 1/1/2028.
• The implementation date of the revised market risk framework finalised in January 2019 was deferred by one year to 1/1/2023.
• The implementation date of the revised Pillar 3 disclosure requirements finalised in December 2018 was deferred by one year to 1/1/2023.

Key features of the postponed Basel III reforms

The reforms of the Basel III standards are meant to reduce excessive variability in risk-weighted assets (RWAs) and to improve the comparability and transparency of banks. To that end, the reforms notably include an “aggregate output floor”, which means that banks using internal models to determine the amount of RWAs may only deviate to a certain extent from the amount calculated by the standardised approach.

The output floor was introduced as a response to lost faith in the robustness of internal models, given the inconsistencies in RWA calculations that seem unjustified by risk fundamentals (see, for example, Breuer on the results of the European Banking Authority’s market risk benchmark exercise), and it shall prevent that RWAs fall below levels deemed inappropriately low. That safeguard is gradually phased in over a six-year transition period. At the start, the output floor limits the deviation to not go below 50% of the standardised calculation, the binding lower threshold then gradually increases over time and finally reaches 72.5% when fully phased-in (during the phase-in period supervisors can, at national discretion, cap an output floor-induced increase of a bank’s RWAs).The revised market risk framework, inter alia, introduces a simplified approach for banks with small or non-complex trading portfolios, revises the treatment of foreign exchange risk, and revamps the risk assessment process for individual trading desks and internal models.

The revised Pillar 3 disclosure requirements, inter alia, define what information has to be disclosed about the calculation of RWAs (bank's internal models versus standardised approaches), the level of asset encumbrance and, where applicable, on capital distribution constraints.....

Full Brief

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