Before they became standards on Thursday, 7 December 2017, the proposals (BCBS, 2015a, 2015b, 2016a, 2016b, 2016c) of the Basel Committee on Banking Supervision (BCBS) had spurred a heated debate amongst regulators , banks, and politicians on the merits that the new supervisory standards would bring to the resilience of banks as opposed to the potential burden that they would bring to the operational cost and the cost of capital. Since they became standards, the Basel reforms pose challenges as to the implementation of the new rules that the international banks have to cope with.
The new framework recommends supervisors to impose new capital requirements for going concern to mitigate the riskiness of non -defaulted exposures. The current chapter intends to provide the reader with the initiative of the publication, describe the target audience, and portray the applicability of the bookâs content by the stakeholders. In doing so, it briefly discusses the content of the book and describes why and how it is beneficial for each of the stakeholders.
1.1 Initiative of the Publication
The main argument of those who oppose the implementation of the new framework is that it would pose an additional operational burden to some banks , which already struggle to comply with the existing set of regulatory and reporting requirements on capital, leverage, and liquidity . It is undeniable that the compliance with the new framework will put an additional operational burden on banks. This burden translates into the additional effort and human capital for the implementation of the new provisions. However, the most prominent concern of the criticism relates to the additional regulatory capital which the new framework may imply for most of the banks. The additional required capital could also lead to some second-order effects which relate to reputational risks, market confidence, and funding costs as well as competitiveness. The implementation of the new framework becomes even more challenging if we consider it in the context of the social pressure on international banks to boost economic recovery through the provision of credit to corporates and retailers.
Given that the various pieces of regulation seemed to have been designed in isolation, the actual integrated impact could be above the sum of the impacts of each individual component. Moreover, a set of changes to one type of risk may also require further amendments in the future to another type of risk, which could only be identified in practice (Deloitte, 2015).
Apart from the one-off operational burden arising from banksâ internal reorganisation to implement the new framework, some associate the new rules with high ongoing compliance costs. Even before the publication of the final Basel III reforms, the banking industry was mindful of the increased costs of compliance with the existing version of Basel III regulation at that time (English & Hammond, 2015). The completed Basel III package will add to the regulatory cost of the existing Basel III part before even the full implementation of the latter.
Against this background, the book provides the reader with guidance on the methodology for the estimation of capital requirements under the final Basel III and with evidence on its impact with a view to inform banks, regulators , and supervisors . This would enhance their awareness and facilitate timely future reactions, ensuring a smooth transition to the new supervisory environment. The present book also unveils implications that the new framework may have when banks try to interpret the new regulatory framework or when they apply it.
Currently, large and internationally active banks continue arguing on the need to reduce the increased capital requirements but, due to the wide spectrum of the proposed revisions, it is likely that they will, anyway, have to invest in infrastructure and human expertise to address future compliance requirements, especially those relating to internal models. On the other hand, smaller banks, which do not have the capacity to build costly internal models, should reflect on the transformation of standardised approach (SA) methods which have now become more complicated than they used to be under Basel III (BCBS , 2016a, 2016b). In the absence of adequate human resources, banks of all sizes and banking models may also consider outsourcing the ongoing compliance to external providers of this service. The outsourcing of the implementation of the Basel reform package implies that the current book would be particularly useful for consultants who are the natural candidates for assisting banks in implementing the new framework.
Thus, the book intends to provide guidance on the implementation of the incremental elements of the final Basel III framework and its subsequent impact, as well as to shed light on the most common issues and dilemmas that banks are likely to face. Furthermore, it addresses the open question as to whether the social benefits of additional banking resilience, arising from the implementation and ongoing application of the reformsâ package, offset the final cost in terms of additional capital requirements.
One of the aims of the reforms is to reduce the variability of risk-weighted assets (RWAs) by introducing a framework that would be less reliant on fluctuating risk parameters. To address this issue, the book compares the differences between SA and the internal ratings-based approach (IRBA ) under the existing Basel III and the final Basel III, seeking evidence on whether the new framework achieves its scope. The wide variation of internal modelsâ specifications, which is the result of a bespoke application of the rules, implies that two different models could result in different amounts of minimum capital requirements for the same institution.
The book investigates the impact of setting minimum values in the inputs and outputs of credit risk internal models as well as the impact that banks would have to face for the application of alternative specifications of the standardised measurement approach (SMA) for operational risk. Concretely, it assesses the capital impact of the BCBSâs proposals in terms of additional future Pillar I (Chap. 2) capital requirements (final Basel III) on the current minimum Pillar I capital requirements (existing Basel III). To this end, it does not take into account any amount of Pillar II (Chap. 2) capital requirements mainly because the nature and applicability of Pillar II capital requirements differ amongst jurisdictions but also because there is no information on Pillar II capital that is readily available to researchers.
The assessment of the impact will focus on âanalysis of deltaâ, that is, the analysis of the incremental impact assuming full implementation of Basel III. To this end, the elements of Basel III, which remain unchanged in the new framework, are not considered in the analysis of the impact. These parts include the liquidity coverage ratio (LCR ) and the net stable funding ratio (NSFR ) as well as capital requirements which do not change under the new framework, that is, the treatment of sovereign exposures, settlement risk, qualifying central counterparties, and other Pillar I capital requirements. Although some of these parts of Basel III are in the pipeline for updates in the near future, the book does not include them in the final Basel III package, as there is no evidence on the direction that these updates will take. As Basel III adopted some parts of the Basel II framework, such as the treatment of specific types of exposures under credit risk, the âanalysis of deltaâ of these parts will implicitly refer to comparisons with the Basel II framework too.
For the purposes of the analysis of this book, the set of Basel reforms includes the revised framework for minimum capital requirements for market risk (BCBS, 2016a), the revisions to the SA for credit risk (BCBS, 2015b), the revisions to the IRBA for reducing variation in credit RWAs arising from the use of internal model approaches (BCBS, 2016c), the revisions to the Basel III leverage ratio (LR) framework (BCBS, 2016d), the SMA for operational risk (BCBS, 2016b), the review of the credit valuation adjustment (CVA) framework (BCBS, 2015a, 2017b), and the reduced-form SA for market risk capital...