Scenario 1: “Let’s press ahead”. This might be based on a negotiated package, with the changes to credit risk (revised standardised and internal ratings based (IRB) approaches) and to operational risk (revised standardised approach and withdrawal of internal model approach) as proposed in January, but with a lower output floor and/or a longer transition period than was proposed in January. An alternative would be to apply the earlier proposed output floor to a revised standardised approach to credit risk, but that would seem even more difficult to agree.
Scenario 2: “Let’s wait a while longer”. This seems the most likely immediate outcome, as either (i) the various US delegations ask for time to reconsider their positions in light of pressures back home, or (ii) those opposing an output floor dig into their trench on the basis that a US repositioning seems inevitable at some point. Nothing then happens in March – but this is not the end of the world for regulation because the current position just continues as Basel 3 plus the revised market risk framework, with the Basel 2 approaches to credit and operational risk. Indeed, that is exactly the position reflected in the European Commission’s proposals for CRR2 and CRD5, as published last November.
Scenario 3: “Let’s do that we can agree on today”. It would be possible to delay the application and calibration of an output floor, and to press ahead with the other remaining parts of Basel 4, namely the proposed amendments to the standardised and IRB approaches to credit risk and the move to a new standardised approach to operational risk. Individual jurisdictions could then choose to go further if they wanted to (as Norway and Sweden have already done, and as the ECB’s thematic review of internal models might lead to).
Scenario 4: “Let’s agree to differ and call a halt”. This has the same immediate effect as Scenario 2, but with no prospect of any further agreements. This might result, for example, from the US ceasing to participate in the Basel Committee (an extreme outcome) or participating only on the basis of an “America first” agenda that undermines the collective spirit of international standard-setting.
Somewhere in the midst of all this we also have the implementation of IFRS9 from January 2018 and its interaction with capital ratios; and the Basel Committee apparently has a consultation paper ready to issue on the capital treatment of sovereign risk. The latter has every potential for generating differences in view between the US and (some) European countries, which may not help with the Basel mood music.
For more information on this, please contact Clive Briault.