Basel IV: Standardising risk and capital calculations

Learn how Basel IV will change internal risk models, operations and reporting and, in turn impact the solutions and pricing, banks can offer to clients.

The regulatory recap

Basel IV: continuing and complementing the aims of Basel III

The Basel Committee on Banking Supervision (BCBS) introduced the Third Basel Accord (Basel III) in 2009 in response to the global financial crisis. Its aim was to strengthen regulation, supervision and risk management in the banking sector, and provide greater assurance and confidence to corporate and institutional clients. Basel III impacted corporate treasurers in a variety of ways; for example, under banks’ liquidity coverage ratio, clients’ operational and non-operational cash were treated differently, resulting in new deposit solutions to reflect banks’ risk appetite for different types of cash.

Since then, BCBS has been reviewing risk measurement approaches, resulting in additional measures proposed in 2016-17 to continue and complement the Basel III reforms. Although these measures are referred to as ‘finalised reforms’ by the BCBS, given the scale of change, they are more commonly referred to as the Fourth Basel Accord (Basel IV) or Basel 3.1. Like Basel III, the new requirements aim to create a more robust capital framework and increase confidence in the banking sector. Some of the new measures that Basel IV introduces include the standardising of the risk-weighted asset (RWA) calculations used by banks and limiting the use of internal ratings-based (IRB) models. By doing so, the BCBS aims to reduce variations resulting from banks’ internal models.

Most of the changes introduced by Basel IV take effect in January 2023 (delayed from January 2022) to give banks time to adapt their internal risk models, operations and reporting, and work with their customers to understand the impact on their solutions and, in turn, pricing.

Scope, scale, and structure

A global impact

The RWA calculation is used to determine the capital requirement, or capital adequacy ratio, required by a bank. The standardised approach is not only more stringent than IRB but also based on different factors. Under Basel IV, banks’ own IRB models used to calculate capital requirements must be at least 72.5 per cent of the standardised approach (known as the ‘output floor’), with banks having to ‘top up’ any shortfall in risk weightings and capital allocation. This could result in banks allocating more risk and capital to many of their products, which could impact pricing, resulting in some products becoming less commercially viable. The European Banking Authority’s (EBA) impact assessment dated December 2019 indicates that RWAs will increase by an average of 23.6 per cent based on full implementation of Basel IV, with a total capital shortfall of EUR125 billion for European banks alone.1

The impact on global systemically important banks (i.e. the 29 leading regional and global banks considered “too big to fail” in terms of the wider economic and market impact that this would have) is greater than for the wider banking community, with a higher leverage ratio. Most multinational corporations will bank with one or more of these banks, which include Standard Chartered.

Building the blueprint for your business

Working with banks to explore potential effects

Given the delay to the implementation of Basel IV, and refinements still taking place, the specific impact on solutions being offered to corporate treasurers and FI clients is not yet clear. Furthermore, some measures, such as the output floor (i.e. the rule around capital requirement calculation described above) are not due to be enforced until January 2028.

However, there are some early indications of issues that corporate treasurers and their bank should consider. For example, the use of standardised models for calculating RWA is likely to result in the pricing of banking products becoming more consistent across the industry. On one hand, this is a positive development for treasurers; however, with banks needing to hold more capital, the price of some banking products could increase. Banks may need to be more selective in the products they offer, which could lead to less choice and competition. Corporates without an external credit rating could be particularly impacted, due to a significant RWA increase for unrated entities under Basel IV, increasing from 20 to 50 per cent today to up to 100 per cent.

One area that we anticipate to be impacted is Trade Finance, particularly documentary instruments such as collateralised trade loans, letters of credit and guarantees. The majority of international trade continues to be based on documentary instruments, particularly in emerging markets, even though we were seeing a gradual shift towards open account. During the pandemic however, with confidence in trading partners shaken, we have seen a revival of interest in documentary instruments, although it is not clear whether this is short term anomaly, or a more permanent shift. Treasurers should start discussing their trade finance requirements with their banks well before the 2023 date to establish which products and solutions would continue to be viable for them from a pricing perspective and how they can continue to manage risk in their supply chains.

Building the blueprint for the industry

Building transparency and trust

Given that the new regulations are still subject to refinement, and most banks have not yet finalised their implementation plans, some ambiguity and uncertainty still exists. For example, given the vital role of trade in the global economy, changes in pricing for trade instruments would have an impact on corporations and the real economy, which would be an unintended consequence of the Basel IV regulations. Banks are engaging with regulators bilaterally and collectively through industry associations to work through the implications, refine requirements, and achieve the best outcome for clients.

This is particularly important in trade finance given the scale of the trade finance gap that already exists, and its disproportionate impact on small businesses and emerging economies. The first of the United Nations’ (UN) Sustainable Development Goals is to eradicate poverty2. Trade is a source of growth, development and jobs, which are crucial to achieving this goal. Today, however, the inability to access trade finance is one of the top three export obstacles of half of the world’s economies, in particular the poorest.3 In 2019, the Asia Development Bank calculated the global trade finance gap as around USD1.5 trillion, with nearly 60 per cent of survey respondents expecting the gap to increase further, even before the impact of Basel IV is factored in.4

Championing change with Standard Chartered

Representing stakeholders to avoid unintended consequences

Standard Chartered strongly supports measures that make the banking sector more resilient, build trust, and create greater assurance for our clients. However, we also recognise our role in getting the spirit of the regulations right, so that new regulations achieve their intended purpose, without damaging consequences for our clients and the wider economy. We are committed to working with regulators and industry bodies, both individually and collectively, to represent the needs of our stakeholders, and ensure that key instruments remain viable, attractive and available to all relevant client groups. We will also continue to work closely with our clients to understand the implications of the new measures on their liquidity, risk and trade finance activities, and find ways to manage change and mitigate any potentially disruptive consequences as seamlessly as possible.