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Basel III Endgame: Major Banking Adjustments Are Likely Incoming

by internationalbanker

By Nicholas Larsen, International Banker


It may sound like the final offering in a trilogy of Marvel Studios superhero movies. And while the real-world banking-system version might not be as exciting, Basel III Endgame (B3E) certainly bears significance as the final piece of the global regulatory response to the 2008 Global Financial Crisis (GFC)—an event that rocked the world. The US regulatory heavyweights have weighed in with their proposals regarding the regulatory capital framework for large banks, replete with amendments in light of the banking turmoil that surfaced in March 2023, meaning that tougher capital requirements are inching closer to being realised for much of the banking industry.

On July 27, the Board of Governors of the Federal Reserve System (the Fed), the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) jointly issued their proposals for the US banking system under the Basel III framework, which seeks to provide the necessary regulatory robustness for a resilient banking system in the post-2008 world. The proposed amendments, “The Notice for Proposed Rulemaking (the NPR or the proposal) for the Fundamental Review of the Trading Book (FRTB) and Basel III Finalization” or collectively “Basel III Endgame (B3E)”, follow from the capital regime that was originally finalised by the Basel Committee on Banking Supervision (BCBS) in December 2017.

In short, B3E will fundamentally change how large banks—those with $100 billion or more—and their depository institutions (DIs) manage their capital. The latest proposals will apply to all banks with $100 billion or more in total assets; that said, specific rules apply to different bank groups, which have been divided by the three agencies into four distinct categories:

  • Category I: US global systemically important banks (GSIBs),
  • Category II: banks with more than $700 billion in total assets or more than $75 billion in cross-jurisdictional activity,
  • Category III: banks with at least $250 billion in total assets or at least $75 billion in nonbank assets, weighted short-term wholesale funding or off-balance-sheet exposures,
  • Category IV: other banking organisations with $100 billion to $250 billion in total assets.

Capital requirements for banks’ trading activities are expected to balloon—and for some, more than double. Indeed, the agencies have projected that their proposals will boost aggregate binding Common Equity Tier 1 (CET1) capital requirements by about $170 billion (approximately 16 percent) for large banks. At 19 percent, GSIBs will experience the largest increases in capital burdens.

For those banks with less than $100 billion in total assets, “the market risk provisions of the proposal would also apply to those with significant trading activity”, the proposal noted. In comparison, capital requirements would not change for community banks.

The new goals will also be ostensibly accomplished by revising the capital framework for banks with total assets of $100 billion or more in four main areas:

  • Credit risk, which arises from the risk that an obligor fails to perform an obligation;
  • Market risk, which results from changes in the value of trading positions;
  • Operational risk, which is the risk of losses resulting from inadequate or failed internal processes, people and systems or external events; and
  • Credit valuation adjustment (CVA) risk, which results from losses on certain derivative contracts.

But the proposals aim for less reliance on proprietary internal models and data to calculate certain risk metrics within Categories I and II banking organisations, instead utilising a new “expanded risk-based approach” that would strive to standardise calculations of risk-weighted assets (RWAs) across the banking sector consistent with the B3E framework. Under the proposal, relevant banks would be subject to standardised risk weights for credit, equity, operational and credit valuation adjustment (CVA) risk—although internal models may still be permitted for market-risk calculations, subject to regulatory approval. That said, large banking organisations could calculate their risk-based capital ratios under the existing standardised approach and the expanded risk-based approach. But the higher of the two numbers would ultimately be used to set the firm’s minimum capital requirements.

Another important change regulators seek is the inclusion of cross-jurisdictional derivatives claims in calculating the capital requirements of Category I GSIBs. And starting in 2028, banks with more than $100 billion in assets may need to include “accumulated other comprehensive income” (AOCI) in their regulatory-capital calculations, meaning that those lenders with unrealised losses in their available-for-sale bond portfolios will need to hold capital against those losses. The AOCI opt-out currently available for Categories III and IV banks will also be removed, so lenders in those categories must recognise unrealised gains and losses in their available-for-sale portfolios. Furthermore, they will be treated the same as their Categories I and II counterparts by becoming subject to capital-deduction and minority-interest rules.

Additionally, following the banking turmoil in March 2023, the proposal seeks to further strengthen the banking system by applying a consistent set of capital requirements across large banks. In particular, the proposal would require banks with total assets of $100 billion or more to include unrealised gains and losses from certain securities in their capital ratios, comply with the supplementary leverage ratio (SLR) requirement and adhere to the countercyclical capital buffer (CCyB) if activated.

A final ruling on these proposals will not be made until at least July 1, 2025, while the agencies have also earmarked an additional three-year phasing-in period until June 30, 2028, for most of their amendments. Banks thus still have considerable time to make internal assessments and modelling adjustments to remain in compliance with the new rules as well as complete adjustments to strategies and fulfil new technology requirements. The proposals are also open to comments and responses until November 30, so time remains for the banking industry and other relevant stakeholders to voice opposing views.

And indeed, robust opposition has already been expressed. A joint letter was sent to the agencies from the Bank Policy Institute (BPI), the American Bankers Association (ABA), the Financial Services Forum (FS Forum), the Institute of International Bankers (IIB), the Securities Industry and Financial Markets Association (SIFMA) and the U.S. Chamber of Commerce (USCC), arguing that the proposed rules and regulations would not only significantly increase capital requirements for larger banks but also repeatedly rely on data and analyses that the agencies have not made available to the public. “This reliance on non-public information violates clear requirements under the Administrative Procedure Act that agencies must publicly disclose the data and analyses on which their rulemaking is based,” the letter issued on September 12 read. “To remedy this violation, the agencies must make available the various types of missing material identified below—along with any and all other evidence and analyses the agencies relied on in proposing the rule—and re-propose the rule.”

Separately, other important banking leaders have voiced their concerns over what they mainly regard as excessively burdensome capital requirements. For many, the narrow focus of this burden on banks—not on nonbanks—represents a major problem. “They’re dancing in the streets,” JPMorgan Chase’s chief executive officer (CEO), Jamie Dimon, said during a July 14 call about the bank’s second-quarter earnings in response to a question about the tightening regulations banks are facing—while nonbanks, such as Apollo Global Management, are enjoying all-time high share prices. “This is great news for hedge funds, private equity, private credit, Apollo, Blackstone,” Dimon added.

And Morgan Stanley’s CEO, James Gorman, shared his displeasure with rules for the US banking system being decided outside the country. “Europe has not even caught up and complied with its own Basel rules,” Gorman told Bloomberg on July 28, one day after the proposed regulations were published. “For the US economy to thrive, we need a strong banking system, led by the largest banks in the country, and we should determine what is the right capital structure of our banks, not have it determined by some other body outside of this country. In the national interest, we should do it.”

Will banks have to drastically change their strategies—and even be forced to sell assets—in response to these onerous capital requirements? It seems unlikely at this stage. “We take no view on the magnitude of banks’ RWA mitigation,” according to Goldman Sachs’ bank-equity analysts, as reported in the Financial Times on August 1. “Banks have historically been able to reduce RWA increases from regulatory capital rule changes as they adapt to new standards, and we expect this to occur with the Basel III Endgame, although it is difficult to estimate the amount of RWA mitigation without knowing which businesses will be most impacted.”

Paco Ybarra, CEO of Citigroup’s institutional client business, meanwhile, said he expects a movement of risks from banks to nonbanks as the financial system finds a new balance. “Most likely there will be a significant business for us to do, still, after the rules happen. Businesses have shown many times that they can adjust,” Ybarra told Bloomberg shortly before the regulators released their proposals.


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