Preparing for Basel III Endgame: Key Changes and Implications for Big Banks

The banking turmoil that started in March 2023 represents the most severe global banking stress since the Great Financial Crisis. This period saw major bank collapses, including Silicon Valley Bank, First Republic, and Signature Bank, along with the distressed sale of Credit Suisse, leading to a crisis of confidence and significant financial market disturbances.

This situation prompted the Basel Committee on Banking Supervision to review and propose enhancements to the Basel III framework, termed the Basel III Endgame. These reforms aim to boost the banking system’s resilience by updating capital requirements and refining regulatory strategies to better address systemic risks. It aims at enhancing the resilience of large banking organizations. This proposal introduces comprehensive amendments to the regulatory capital framework, targeting banks with significant trading activities and those holding assets worth $100 billion or more. Here’s an overview of the key aspects and anticipated impacts of this regulatory overhaul.

Overview and Timeline

The Basel III Endgame proposal, introduced on July 27, 2023, aims to standardize capital requirements across large banks to mitigate various risks, including credit, market, operational, and financial derivative risks. The proposal mandates banks to include unrealized gains and losses from certain securities in their capital ratios and adhere to supplementary leverage and countercyclical capital buffer requirements. The transition to the new framework is scheduled to begin on July 1, 2025, with full compliance expected by July 1, 2028​​.

Expected Impact on Banking Institutions

The proposed changes are expected to increase common equity tier 1 capital requirements by 16% on average for affected bank holding companies, primarily impacting the largest and most complex banks. The effects will vary based on each bank’s activities and risk profile. The proposal targets improvements in four main risk areas:

  • Credit Risk: The risk that an obligor fails to meet their obligations.
  • Market Risk: The risk arising from changes in the value of trading positions.
  • Operational Risk: Losses resulting from inadequate or failed internal processes, people, and systems.
  • Credit Valuation Adjustment Risk: Losses on certain derivative contracts.

Large banks will need to incorporate unrealized gains and losses from specific securities into their capital ratios and comply with supplementary leverage and countercyclical capital buffer requirements if activated​​.

Changes in Regulatory Capital and RWAs: Banks with over $100 billion in assets must include accumulated other comprehensive income (AOCI) in their regulatory capital calculations starting in 2028. This change aims to create a consistent capital adequacy framework across large banks​​.

Data and Technology Enhancements: Banks will need to invest significantly in data aggregation and management to ensure compliance with the Expanded Risk-Based Approach (ERBA) and revised stress testing methodologies. This includes upgrading technology to handle new RWA calculations and stress testing requirements. Enhanced capabilities in these areas are crucial for meeting the stringent standards set by the proposal​​.

Operational and Strategic Adjustments: Banks must review their business models and portfolios to manage capital requirements and maintain profitability effectively. This includes considering the impact of new products on capital requirements and maintaining proactive communication with stakeholders about the proposal’s implications. Adjustments might involve rebalancing portfolios and developing strategies to manage increased capital needs​​.

Reporting Changes: The proposal includes substantive revisions to the Consolidated Reports of Condition and Income to align with the new regulatory capital framework. These changes are set to take effect in the third quarter of 2025, consistent with the proposed capital rule’s timeline​​.

Conclusion

The Basel III Endgame proposal represents a significant step towards bolstering the resilience of the banking sector. By standardizing capital requirements and addressing various risk factors, it aims to create a more robust and stable financial system. Banks must prepare for these changes through substantial investments in technology, data management, and strategic adjustments to meet the new regulatory demands.

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