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Basel IV – Banks should act now on capital and strategic planning

Basel IV – capital and strategic planning

The revised standards to the Basel III framework are expected to hold a number of impacts on European banks if adopted in full.

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The package of changes to the Basel III framework informally known as `Basel IV' was formally endorsed on December 7 (High-level summary of Basel III reforms (PDF 276 KB)). There is now intense debate about the likely impact of Basel IV on risk weighted assets and the resulting amount of regulatory capital banks will be required to hold under the new rules.

Based on KPMG's Peer Bank tool, which includes a Basel IV Calculator, and applying recent EBA Quantitative Impact Studies to bank specific portfolios, we expect the revised standards to hold a number of impacts on European banks if adopted in full. In particular:

  • On average, the common equity Tier 1 (CET1) capital ratios of major European banks would fall by around 90bps. However, the range of impact is wide. Some banks may see little change to their capital ratios, while others face a significant decrease. The most affected decile could see a decrease by more than 4%, while the least impacted decile experience a decrease of just 18bps.
  • The greatest CET1 impact (averaging 2.5 - 3%) would fall primarily on banks in Sweden and Denmark, followed by those in Norway and the Netherlands (decreases of around 1.5%). This mainly reflects the balance of those banks' asset portfolios, and the extent to which they have used IRB models for their calculations of capital requirements.
  • The impact on pillar 1 capital requirements will vary according to different banks' business models. Our analysis suggests that more focused models will be hit harder. For example, asset managers could see a decrease of around 2.8% and sector lenders a decrease of approximately 1.6%. The average decrease for G-SIBs will be around 70bps. The increased risk sensitivity of wholesale portfolios might push the CET1 requirements of a typical wholesale lender down by around 0.9%.

The additional capital requirements of Basel IV will be driven largely by restrictions to the IRB approach, such as moving portfolios from Advanced-IRB to Foundation-IRB. And while the introduction of an IRB output floor will have little overall effect, it could have a significant impact on banks with comparatively high mortgage exposures - such as those in Scandinavia and the Netherlands.

In contrast, revisions to the calculation of Credit Risk (Standardised Approach), Market Risk and Operational Risk will probably only account for around 10% of the capital impact of Basel IV. We believe that bank internal calculations differ from these numbers because they typically also include effects due to the Fundamental Review of the Trading Book (FRTB), amongst others.

Given they are subject to a long transitional period, the capital requirements of Basel IV look manageable for most European banks. If anything, the required changes to banks' business models, their response to the low interest environment and weak profitability, are likely to have a more widespread impact - a fact highlighted by the ECB's 2017 SREP decisions.

Now that the specifications of Basel IV have become clear, we will see European banks begin an all-too-familiar cycle of internal discussion. This cycle will begin with CROs assessing the impact of the new rules on risk weightings. Next, CROs and CFOs will work together to identify the likely capital and operational costs. After that, CEOs can be given detailed briefings and the debate will move on to consider the wider strategic implications, and to agree a set of actions.

KPMG's Basel IV Calculator, part of our Peer Bank tool, has been designed to support these discussions. It allows banks to model the likely impact of Basel IV line-by-line, to gauge the overall effect on key capital metrics, and to benchmark themselves against national, European and sectoral peer groups.

This kind of impact assessment is a key step in enabling banks to plan their responses to Basel IV, and to communicate their expectations to investors and regulators. That is particularly important given the range of other measures - such as P2Rs, P2G and non-performing loans - currently changing bank's capital.

It is clear that capital planning is becoming more challenging than ever, and that European banks need to get on top of this vital issue. However, Basel IV will also prompt banks to reassess their internal models and risk management processes including their value added. We therefore expect banks to include selected Basel IV measures into their planning for reshaping their business models. KPMG can help banks to consider the impact of Basel IV on businesses, processes and capital requirements, and to explore possible reductions to the cost and complexities of their business.

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