The “Basel 4” package aims to strengthen the risk weight system
New regulation in the seven years since the Global Financial crisis has primarily aimed at increasing the quantity and quality of equity banks hold against losses. The next steps, coming to be dubbed “Basel 4”, look to change
how banks measure the “riskiness” of their balance sheets and “advertise” their capital ratios. Last year, in our European Banks report Truth in Advertising 9 June 2014, we looked at how this could happen. We have since had detailed proposals published from the Basel Committee. In this report, we evaluate the impact of Basel 4 by using European banks’ pillar 3 data, giving us the most granular and up to date bank by bank analysis available.
The key changes in the Basel 4 package of measures
In our framework to think about RWA inflation from Basel 4 we consider four
key proposal; i) Credit risk – revisions to standardized approach; ii) Market risk - Fundamental review of the trading book. We wrote about this extensively recently in our report 9 April report, Driving change at Credit Suisse: the FRTB and RWA inflation; iii) Operational risk – revisions to simpler approach; and iv) Capital floors – for banks that use their own internal models to calculate balance sheet risk. We also take into consideration further steps to “clean up” banks’ regulatory equity base.
Basel 4 is broadly manageable but outcomes could vary widely
Depending on calibration of capital floors and other measures, Basel 4 could potentially have a wide range of outcomes. In our base case of a risk-category based floor of 75%, we expect the sector to see 14% RWA inflation. On 2015balance sheets, this would add EUR 1.2tn to listed European banks’ risk weighted assets. This would reduce our B3 forecast from 11.6% to a B4 figure of 9.9% including further measures on equity. However if capital floors are applied more granularly under the so-called portfolio-based measures, RWA inflaton could rise to 22% and impact core tier 1 ratio by a further 0.6%, reducing the sector figure to 9.3%.
Granular analysis by bank, where some may face more payout constraints
In this report we include a detailed template of RWA inflation for each bank under our coverage, with commentary on sensitivities. We summarize in the table on the next page the impacts of the various proposals on core tier 1 ratios for each bank in our universe. Compared to a doubling of equity requirements under Basel 3, the Basel 4 package of measures is likely to be more manageable. However, some banks’ ability to raise payouts will be constrained as they retain capital, thus disappointing market expectations.
2019 implementation, but the market may fully load the impact quicker
Most of the proposals we consider will come into effect in 2018/ 2019. A key piece of feedback from our DB Global Financials Conference is that Basel 4 as a topic is increasingly being discussed by management teams and investors. As such we have an expectation that pressure will increase to guide on the potential impact with the full year results or over the course of the year. The market, as with previous regulation, is likely to fully load the impact into valuations. We have already seen the potential of Basel 4 to drive share prices.
In the table below we detail the impact on capital ratios we expect to see from each source given our base case assumptions.