Basel III Finalization - The Brochure
Find here an overview of changes and the expected impact on Swiss banks.
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The Basel III Finalization reform package
In December 2017, the Basel Committee on Banking Supervision (BCBS) adopted the finalized Basel III framework, which was completed in February 2019 with the revised minimum standard for market risks (Fundamental Review of the Trading Book, FRTB).
The finalization of Basel III is essentially dedicated to risk-sensitive capital adequacy and the interaction of standardized and internal measurement methods. To this end, the significance and risk sensitivity of the standardized approaches will be increased on the one hand and the applicability of internal bank models will be restricted on the other. The revised regulations are also intended to further strengthen the resilience of the global banking system and achieve a transparent and internationally comparable calculation of capital requirements.
As the new regulations apply to all risk types, they affect all banks, regardless of their size and business model and regardless of whether they currently use standardized approaches or internal models to determine their risk-weighted assets (RWA). The revised standards cover a broad range of regulatory changes across all risk types, which aim to achieve a quantitative and qualitative improvement regarding regulatory capital. The adjustments focus on the respective standardized approaches for credit risks, market risks and operational risks for calculating risk-weighted assets (RWA).
EY Basel III reforms survey 2023
73%of respondents have a governed, funded and resourced Basel III Reform program in place
The Federal Council adopted the new regulation for Switzerland on 29 November 2023. Entry into force is scheduled for 1 January 2025, which means that the first reporting date under Basel III (final) is 31 March 2025.
The specific changes under Basel III (final) (and the associated legislative packages) can be found in the brochure attached to this article. We have briefly summarized the most important changes:
- Credit risk: the revised standardized approach to credit risk is intended to increase granularity and risk sensitivity and reduce dependence on external rating agencies. At the same time, the use of internal models (internal ratings-based approach) will be more restricted in certain areas.
- Market risk (FRTB): The introduction of a new market risk standardized approach includes greater consideration of risk sensitivities as well as the introduction of a default risk charge (DRC) and residual risk add-ons (RRAO). The current standardized approach will continue to exist in Switzerland as the simplified standardized approach, as will the de minimis approach, which will also continue to be available in a recalibrated version. In addition, a new internal model approach (IMA) will be introduced, considering tail risks and illiquidity. Finally, a clearer and stricter differentiation and delineation between the regulatory banking book and the trading book will be established.
- Operational risk: The newly designed standardized approach (SMA) replaces all previous approaches. The SMA is based on two key factors: a measure of business size (Business Indicator Component, BIC) and a measure of the financial institution's historical losses (Internal Loss Multiplier, ILM).
- CVA risks: The abolition of the internal model approach (A-CVA) and the simultaneous revision and introduction of a standardized approach (SA-CVA), a basic approach (BA-CVA) and a simplified approach are intended to reduce the complexity of the calculations.
- Output floor: The introduction of a new output floor will limit the regulatory capital advantages for banks that use internal model-based approaches compared to standardized approaches.
- Leverage ratio: Further refinement of the total exposure measure and consistency with the standardized approach for credit risk
What does the Basel III (final) reform package mean for banks in Switzerland?
For banks, the Basel III reforms mean in particular the collection of new data, setting up new derivation and calculation logics, adjustments of existing and implementation of new processes, investments in IT infrastructure, revision of governance, adjustments and extensions to reporting, and much more.
EY Basel III reforms survey 2023
50%of banks identify data as their number 1 or number 2 challenge
Expected impact on Swiss Banks
We currently expect divergence in the impact on RWA across the Swiss banking sector, depending on a number of factors such as the composition of the credit risk portfolios, as well as the magnitude of market and operational risks. Currently, on average, we expect credit risk and operational risk (excl. category 1 and 2 banks) RWA to stay largely flat, whilst market risk RWA to increase slightly. A principle of “capital neutrality” on aggregated level (excl. category 1 banks) was agreed in Switzerland and based on the results of the Quantitative Impact Study 2 (QIS2) conducted between March and May 2021 will, according to FINMA, also be achieved with the presented regulations. However, on individual bank level Basel III Finalization can still lead to changes in RWA.
Planned changes for the standardized approaches will impact all Swiss banks, adding new calculation approaches (e.g., Operational Risk SMA), as well as process requirements and additional data to be collected in order to comply with new calculation requirements.
Due to changes in model requirements and increased complexity in calculations, an increased model governance as well as more stringent data management framework will be necessary. Further, more detailed disclosures in Pillar 3 reporting is to be expected for most Swiss banks.
In general, principles of proportionality may apply to category 4 and 5 banks, and to a certain extent also to category 3 banks.
Due to the complexity and size of changes, the implementation should be addressed in a dedicated project as soon as possible, if not already done.
Summary
Basel III final will impact all Swiss Banks, independent of size and business model, across all risk types.
