Capital requirements could rise further as „Basel 4“ starts to emerge

in Financial Services, 17.09.2013

Even though the original implementation deadline for Basel 3 is still a far-distant 2019, we are already starting to see the emergence of „Basel 4“ – which could require global financial institutions to have to hold even more capital. For example in the UK, the eight largest banks are likely to have to hold an additional £50 billion in capital, according to KPMG’s best estimates.

Regulators around the world – and the banks themselves – have fast-tracked the implementation of Basel 3 as a safeguard against another financial crisis, raising the capital levels that banks must hold. But there are strong signals that we are already moving beyond this to the emergence of the next iteration of the capital standards framework, or „Basel 4“.

This is evidenced by:

  • The gold-plated implementation of Basel 3 in some countries, including the US, UK and Switzerland
  • Some countries, including Switzerland, already moving beyond Basel 3 by requiring banks to hold capital buffers to absorb the impact of stress tests, over and above the Basel 3 minimum capital standards, and setting the minimum leverage ratio above 3%
  • Widespread concerns among regulators and market analysts about banks’ internal modeling and the accuracy of the resulting risk-weighted assets
  • A flurry of papers in the last couple of months from the Basel Committee that look beyond Basel 3
  • For euro bank areas, the prospective actions of the European Central Bank as supervisor, regulator and macro-prudential authority

The pace of change and the desire by regulators to safeguard financial stability at all costs means that the regulatory timetable is getting far ahead of itself. The outlines of “Basel 4” are already becoming visible, five years before the technical implementation deadline for Basel 3. Care needs to be taken that the banks are not being asked to do too much too quickly.

Recent developments are likely to result in three changes that might form the basis of “Basel 4”:

  • Requiring banks to meet a higher minimum leverage ratio
  • Restricting the advantages to banks of using internal models to calculate their capital requirements
  • Greater disclosure of model-related and other information by banks

We caution against an overzealous pursuit of simplicity. An over-reliance on standardized risk weightings or a non-risk sensitive leverage ratio could have perverse consequences. It could encourage banks to hold riskier assets and could significantly increase the cost of funding a portfolio of lower risk-weighted assets, such as mortgages.

“More and more of everything”

Banks must be aware that Basel 3 is but one element of the multiplicity of regulatory reforms under way – the “more and more of everything” approach to regulation is reality. At KPMG, we believe that it is important to take account of the linkages between the Basel 3 minimum capital and liquidity requirements and the additional demands on these scarce resources arising from the multiple regulatory reform initiatives running parallel to Basel 3. Challenging times lie ahead – but slowly, banks are getting used to this.

For further information, please read our latest publication “Basel 4 – Emerging from the mist”.