Focus on Basel output floor calibration misses the point

Until all the final standardised approaches are known, the floor has little meaning

If this past year has taught us anything, it’s that politicians throw around a lot of numbers, which on closer inspection don’t mean a whole lot. So it’s a telling sign of the politicisation of the global financial regulatory framework that officials have worked themselves into an absolute frenzy over a number, which at this point, doesn’t tell us much.

The most recent meeting of global regulators hashing out the revised Basel III framework once again ended in deadlock over the number intended to set a minimum proportion of risk-weighted assets (RWAs), calculated using standardised approaches that would act as a floor for results from banks’ internal models. Europeans, especially the French, firmly rejected any floor above 70%, while modelling sceptics led by the US pushed for one of 75% or 80%.

But, without knowing how the standardised approaches constituting the floor will look, the fight over calibration seems strange. Indications are that the standardised approaches are actually still up for debate – or will be soon – and some inputs that could have a major impact have hardly been debated at all.

A leaked memo written by Basel Committee chairman Stefan Ingves on first reading indicates everything except the floor calibration has been worked out. But, it then goes on to make clear the Basel Committee is worried about the capital impact of some standardised approaches. In the case of counterparty credit risk, for example, they even promise to revisit the calibration of the SA-CCR by 2024.

Left out of the memo is how the standardised approach for credit RWAs – which drive overall RWA numbers because they form the bulk of most banks’ portfolios – will give capital relief for excess accounting provisions. The question has become urgent as new accounting rules are soon set to go online that significantly increase provisioning and are especially punitive for credit exposures subject to standardised approaches. Basel is working on the overlap with regulatory capital, but that has been left behind as the floor-calibration debate reaches fever pitch.

Left out of the memo is how the standardised approach for credit RWAs… will give capital relief for excess accounting provisions

Instead, regulators are seeking to buy time by phasing in all of the difficult stuff. The impact of accounting rules on regulatory capital will be transitioned in, while the Ingves memo also suggests phasing in the impact of certain standardised measures for the purpose of the floor, all the way out to 2027. It’s easy to see why – accounting and modelling are topics reserved for the pointiest of heads, making it hard to discuss them in an increasingly political and tense debate; even industry groups have trouble condensing them into any kind of strong and consistent message needed for a powerful lobby.

Perils of delay

But leaving the technical stuff for later could have its consequences. Regulators may agree on the calibration of the floor, but the real battle will be when they actually find out how that calibration bites in the real world. This will be dependent on all these technical details and inputs. If harmonisation of global standards is the goal, not understanding the impact of those standards is a great way of not achieving it. If the history of Basel rules tells us anything, it is that national regulators aren’t afraid of implementing rules in the way they see fit, depending on how they affect their specific market.

Take the last attempt at a floor as an example. Internationally agreed rules set a floor on banks’ RWAs under Basel II at 80% of what they would have been under Basel I. Likely cognisant of the different make-up of European balance sheets, which tend to have lower risk weights than their US counterparts, European regulators transposed the requirement as a floor on regulatory capital instead. There’s nothing to say that a similar outcome can’t happen again.