Basel 3 implementation: what is still at stake?

An EU vs UK vs US perspective

Sixteen years ago, the collapse of Lehman Brothers triggered the global financial crisis, which highlighted significant weaknesses in the global banking sector. The oversight of the sector was quite fragmented between jurisdictions, leading to inadequacies in regulation and supervision.

In response, the Basel Committee, which sets global standards for the prudential regulation of banks, put forward in 2010 its ‘Basel III framework.’ A core focus was to address inappropriate levels of capital in banks by introducing new capital buffers. The final part of Basel III was later unveiled in December 2017 to tackle the model heterogeneity issue responsible for heterogenous capital requirements.

However, implementing these latest Basel III standards in different jurisdictions has been slow to occur. While the pandemic caused some delays, it also faced political and industry pressures in addition to its inherent complexity – as it requires significant changes to banks’ operations and systems. The Basel Endgame in the US is also now facing mounting challenges and uncertainties.

So, where do we stand now?

“Despite some uncertainties, Basel III is there to stay. Firms must continue their implementation in the EU and prepare in the UK and US based on what is known of the near-final rules.”

David Labella, Director and Group Head of Regulatory Watch, FS RegCentre, Forvis Mazars in France

2025, the light at the end of the tunnel?

On 13 May 2024, the Basel Committee reiterated the importance of implementing these global standards in each jurisdiction as soon as possible, along with welcoming jurisdictions in their final stage of adopting them. Having already provided one more year extension due to the pandemic, it had requested its members to implement its standards by 2023 at the latest.

The last Basel III implementation dashboard showed that while all BCBS jurisdictions are working on making applicable the revised standards as soon as possible, some countries such as Japan, Canada, or Saudi Arabia, are more advanced than others, such as China or India.

When it comes to the three largest Western geographical areas, the US, UK, and EU, all are in the finalisation stage of their adoption process – albeit at different levels and facing different challenges.

Overall, all countries are trying to find an adequate balance between being compliant with the Basel III framework, considering the local specificities, and not being detrimental to their local market.

Indeed, large banks with a global footprint often complain that global fragmentation in regulations creates complexities in implementing the rules. When individual market specificities are considered, it also is important that regulators do not diverge too much when adopting the Basel standards. Timing of implementation also is important to avoid creating significant discrepancies between the main regional zones.

The EU as a front runner for the implementation of Basel III 

The recent publication in the Official Journal of the EU marks the entry into force of the Basel standards into the EU legislation. Banks headquartered in the EU will have to be ready, from 1 January 2025, to report their prudential ratios using the new approaches introduced by the third main amendment of the capital requirements regulation (CRR3), which transposes those standards.

Yet, in the UK and US, banks would only have to comply by 1 July 2025 at the latest, if maintained.

While the so-called UK Basel 3.1 should be finalised after the July General elections, the US Basel 3 Endgame may take more time with an application not expected before 2026. Firstly, the consultation process in the US necessitated two rounds of proposals to encompass the lessons learnt from the 2023 spring banking turmoil. Secondly, political uncertainty regarding the outcome of the US elections is adding concerns regarding a final adoption by US agencies.

“The climate is tense in the US regarding the Basel Endgame, with political pressure and pushback from large banks who find the rules to be restrictive. This could put the current proposal at risk of delays or re-proposal.”

William Rogers, FS Regulatory Practice Leader, Forvis Mazars US

Concerns over the risk of fragmentation of the implementation between jurisdictions

EU banks may be at a disadvantage when applying the Basel reforms compared to banks headquartered in the US or UK, depending on the outcome of the coming months in these jurisdictions.

For example, new rules related to market risk are an important aspect of these standards, since they impact the competitiveness of EU investment banks vis-à-vis non-EU ones. The new article 461a in the CRR3 allows the European Commission to adopt a delegated act to delay for up to two years the application of market risk rules (this comes from Basel III’s Fundamental Review of the Trading Book of Basel – FRTB). This could be applied if there were significant differences between the implementation of FRTB in the EU and third countries.

Echoing some central bankers, notably the Governor of the Banque de France who recently called the EU to postpone some rules if the US does not implement Basel reforms timely and completely, this was materialised on 18 June, when Commissioner McGuinness officially announced that the application of market risk rules in the EU will only apply from 1 January 2026. Other jurisdictions are also applying a wait-and-see approach for the US outcomes with regards to market risk implementation. For example, the UK may now also consider revisiting its implementation timeline for market risk rules.

“We are at a crossroads for ensuring harmonisation of the rules and timing for the implementation of Basel III. Fragmentation between the EU, UK and US could bring significant complexities for banks operating across the different zones.”

Eric Cloutier, Group Head of Banking Regulations, Forvis Mazars in the UK

Divergences may exist between the EU, US, and UK.

We discussed below some material divergences between the EU CRR3 and what we currently know of the US and the UK proposals, should these be maintained in the final texts to come later this year. Read also our previous article on the UK vs US and our article on the Basel III Endgame.

“The UK cannot afford to move too far from the EU CRR3. This is due to the regulatory and market ties still shared by the two jurisdictions.”

Gregory Marchat, Partner and Group Head of Financial Services Advisory, Forvis Mazars in the UK

• Credit risks – External ratings. In general,credit risk mostly accounts for a large part of RWA. One of the main issues addressed by the Basel Committee was to not rely anymore on external ratings for the standardised approach. The US has followed this approach by adopting a uniform risk weight (RW) for corporate exposures depending on their investment or speculative grade. In Europe, the EU and UK kept this approach as well but also allowing banks to still rely on external ratings for assigning exposures to different risk weights.

• Credit risks – Internal ratings. When it comes to modelling, the US chose to completely remove IRB models, whereas the EU and UK transposed faithfully the Basel III IRB reform in keeping advanced IRB at least for high-default portfolios and foundation IRB for low-default portfolios.

• Credit risks – Real estate exposures. This is another important topic. Two approaches will be available for banks depending on how the exposure is being reimbursed from dependent revenues or not. The latter being considered riskier, a new granular approach where the loan-to-value ratio level drives RWA is considered. If the three main jurisdictions have adopted similar approaches, divergence is highlighted in how immovable property collateral is assessed when granting home loans and during the life of the credit. For instance, in the EU the CRR3 provides that an independent assessment should be performed at the origination (which was already sought by the EBA in its 2020 guidelines on loan origination and monitoring), and regular revaluation should be performed, i.e., at least every three years for loans exceeding EUR 3 million or 5% of the bank’s own funds.

• Operational risks. Jurisdictions can set the internal loss multiplier or “ILM” at 1, i.e., to neutralise its effect on the capital requirement, which means that the calculation will rely on the sole Business Indicator Component. This may be seen as a competitive advantage if firms have a significant loss history, however, all three geographical areas have used this option. This new standardised measurement approach (SMA) will become the sole approach available for banks along the removal of the existing advanced approach (AMA).

• Market risks. EU banks have already implemented the new standardised approach introduced by the FRTB, for reporting and monitoring purposes. However, new internal model approach (IMA) under the Expected Shortfall will have to be developed by applying banks and seeking authorisation from their respective supervisor, for instance, the ECB in the EU. So far, it seems that only a few banks in the EU will apply for it, which means that many banks will refrain from using current VaR approaches for calculating their capital requirements and instead will rely on the alternative standardised approach. The initial objective of the Basel Committee is to elevate the standardised approaches as credible fallback approaches to internal model ones turn out to materialise.

• Credit valuation adjustment risk. Finally, from the CVA risk perspective, every firm that currently leverages the advanced approach for calculating capital requirements, will, from 1 January 2025. Only rely on the new standardised approach (SA-CVA) or, as an alternative, the basic approach (BA-CVA). Firms are required to obtain approval from their supervisor to use the standardised approach, considering the synergies it has with the IMM for counterparty credit risk, IRB for credit risk or sensitivities for market risks. Some banks may see their capital requirements significantly increase, such as even doubling or tripling, depending on if SA-CVA or BA-CVA will apply to them.

While the reforms were long expected, they require careful planning and investments.

The finalisation of Basel III was released in 2017, the Fundamental Review of the Trading Book (FRTB) in 2019, and the revised CVA framework in 2020. The first consultative documents were issued in 2012, and large banks largely have contributed to the numerous QIS that the Basel Committee performed. Most of the main policy choices should, therefore, be well known by the industry.

However, when implementing all these reforms, each part will necessitate careful assessment by banks. For instance, self-assessments between current and new rules are typical exercises that banks need to perform to understand possible gaps to fill. Adapting risk processes and governance is another important issue to consider, especially in providing the necessary tools to perform the calculation of RWA with the new approaches. Finally, it is important to make the appropriate changes within IT systems to report compliantly to competent authorities.

All these aspects need experience in implementing new regulations and understanding regulatory texts.

What’s next?

In the EU, the CRR3 was recently published and will enter into force in July for an application of CRR3 from 1 January 2025. Shortly after the publication of CRR3, it was announced that the application of the market risk rules in the EU will be postponed to 1 January 2026.

On the other spectrum, the situation in the US is much more uncertain. While the US regulators reiterated their commitment to implement Basel III, the Basel Endgame is currently facing significant political pressure and pushback from some of the largest banks. It is currently unknown how significant the revisions will be, and if these will cause significant delays in implementation.

Major deviations or delays from the US package could have ripple effects on other jurisdictions. As mentioned earlier, this could impact the market risk rules and timing for some jurisdictions – including the EU.

In the UK, the electoral races for Downing Street led to the postponement of the publication of the final Basel 3.1 (initially expected in June 2024) until after the election of 4 July 2024. This is standard practice from UK regulators during elections and is not a sign of a potential issue. However, if the US proposals were to be considerably delayed, or change significantly to become materially less restrictive than the UK, some revisions also may be contemplated in the UK to align. The postponing of the implementation date for market risks in the EU also likely will be taken into account in the UK.

“The UK elections, combined with the summer holiday period, means that September now appears to be the earliest date for the near-final rules to be published in the UK. This would only give banks less than nine months to implement the proposals, possibly putting in question the current implementation date of 1 July 2025.”

Freddie Blake, Associate Director of Financial Services Consulting, Forvis Mazars in the UK

There is, therefore, a lot of uncertainty and speculation at the moment, with many moving parts at play. We can only wait for the outcome from the US to know what the real changes will be, if any.  

Despite these uncertainties, Basel III is here to stay. Banks must continue their implementation in the EU and prepare in the UK and US based on what is known of the near-final rules.