Capital requirements | KPMG | BE

Capital requirements

Capital requirements

KPMG professionals estimate that if the revised standards were implemented in full for the 128 European banks in the KPMG Peer Bank tool...

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Capital requirements

KPMG professionals estimate that if the revised standards were implemented in full for the 128 European banks in the KPMG Peer Bank tool:

  • On average, the common equity tier 1 (CET1) capital ratios of these major European banks would fall by around 90 basis points. However, the range is wide: 10 percent of banks would suffer a CET1 capital ratio reduction of at least 4 percentage points. 
  • More than half of this impact would be driven by the constraints on the use of internal ratings based (IRB) models to measure credit risk – for most banks the output floor has only a minor impact once these IRB model constraints are imposed.  The additional impact of the output floor reduces the CET1 capital ratio of 12 banks by at least 50 basis points.
  • The largest impacts (CET1 capital ratio reductions of 2.5-3 percentage points on average) would fall primarily on banks in Sweden and Denmark, followed by banks in the Netherlands and Norway (a reduction of around 1.5 percentage points), reflecting mainly the balance of their asset portfolios and the extent to which they have used IRB models to drive down capital requirements.  
  • In terms of peer groups, banks with more focussed business models are most affected by the revised standards, with average reductions in CET1 capital ratios of 2.8 percentage points for asset managers and custodians, and 1.6 percentage points for sector-specific (mostly real estate) lenders. The average reduction for universal banks and for European G-SIBs is around 0.7 percentage points.

Banks using internal model approaches for credit risk will need to (a) apply the constraints on the use of the IRB approach for credit risk;  (b) calculate the output floor as 72.5 percent of the total of the revised standardised approach (SA) calculations for all credit and market risk exposures and the new standardised approach for operational risk; and (c) apply the output floor if the use of internal model approaches for credit and market risk would otherwise drive overall risk weighted exposures below the output floor.

The largest impacts on these banks will be where:

  • The IRB constraints force banks to apply higher risk weights to high quality exposures where no IRB approach can be used (equities); where the advanced IRB approach can no longer be used (exposures to banks and to large corporates); or where tougher parameter constraints apply under IRB approaches (in particular on mortgage lending and credit card lending);
  • The standardised approach for operational risk generates a much higher capital charge for banks that previously used a more advanced approach, or that have high recent misconduct costs;
  • The output floor constrains the extent to which banks can drive down their capital requirements through the use of internal models for credit and market risk; and
  • Measured counterparty credit risk increases for banks that have to switch from using an internal model method for credit risk mitigation to the more penal standardised approach to counterparty credit risk for the purpose of applying the output floor.      

Banks using the Standardised Approach (SA) for credit risk will need to move to the revised SA for credit risk. This will drive higher capital requirements for some types of lending, including buy-to-let and similar exposures to property where repayment relies on income from the property. However, for some banks the lower risk weights on high quality credit exposures under the revised SA may result in reduced capital requirements. 

The impact on banks will be cushioned by the long transitional period, in particular for the output floor, although – as with earlier elements of Basel 3 - they may face pressure from supervisors, rating agencies and market analysts to meet the ‘fully loaded’ revised standards ahead of schedule. 

Banks may also gain some offset to higher Pillar 1 capital requirements through national supervisors agreeing to reduce Pillar 2 requirements or other capital buffers – on the basis that these add-ons in part reflected the risks posed by the use of internal models. In addition, banks that can demonstrate good internal modelling and strong systems and controls for operational risk could potentially gain a partial Pillar 2 offset to higher Pillar 1 requirements.

Equally, however, the impact of the revised standards will add to the reductions (on average of around 0.5 percentage points) in CET1 capital ratios driven by the introduction of IFRS 9, and many European banks could be vulnerable to prospective changes in the capital treatment of sovereign exposures. 

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