Basel Committee Outlines Updated Policy Agenda, Including Plans to Finalize Outstanding Revisions to Its Regulatory Reform Framework by the End of 2016

The Basel Committee on Banking Supervision1 (the “Basel Committee”) and its Chairman, Mr. Stefan Ingves,2 have recently outlined the Basel Committee’s plans to finalize “the Basel III reform package”3 and the next steps to address the “fault lines” stemming from two broad dimensions thus far unaddressed by the Basel III reforms: the way in which risk is measured—that is, reliance on banks’ own estimates of risk—and risk weighted-approaches that are “essentially the same as they were before the crisis.”4

In summary, the Basel Committee plans to finalize, by the end of 2016, remaining post-crisis reform initiatives in three broad categories: (i) enhancing the risk sensitivity and robustness of the standardized approaches, (ii) reviewing the role of internal models in the capital framework, and (iii) finalizing the design and calibration of the leverage ratio and capital floors. More particularly, by the end of 2015 the Basel Committee plans to:

  • Finalize its fundamental review of the trading book, which will include:
    • a revised standardized approach for market risk that is “sufficiently risk-sensitive to act as a credible fallback to internal models while still being appropriate for banks that do not require a more sophisticated measurement of market risk;” and
    • an enhanced internally-modelled approach for market risk.
  • Consult on a revised standardized approach for operational risk and on removing the use of the advanced measurement approach for operational risk.5
  • Consult on revised proposals on the standardized approach for credit risk, which the Committee notes “may include the use of external credit ratings in a non-mechanistic manner.”6

Furthermore, during 2016, the Basel Committee intends to:

  • Conduct a quantitative impact study with respect to the revised proposals on the standardized approach for credit risk and finalize possible modifications to the internal ratings-based framework for credit risk to narrow the modelling choices available to banks, “particularly in areas for which the use of models may not be suitable for calculating regulatory capital.”7
    • In this regard, Chairman Ingves expressed particular concern with the reliability and robustness of internally-modelled approaches, stating that “ample evidence has accumulated to suggest that the current role of internal models in the regulatory framework does not strike the right balance between simplicity, comparability and risk sensitivity.”8 Chairman Ingves indicated that the Basel Committee’s planned proposals will remove internally-modelled approaches for some risk categories and introduce additional constraints on their use for others.
  • Incorporate the criteria for the treatment of simple, transparent and comparable securitizations into the revised securitization framework.
  • Finalize its approach to regulatory treatment of interest rate risk in the banking book to:
    • ensure that banks have appropriate capital to cover potential losses from exposures to changes in interest rates; and
    • limit capital arbitrage between the trading book and banking book, as well as between banking book portfolios subject to different accounting treatments.

In addition, the Basel Committee states that it is working on finalizing—in parallel with the revisions outlined above—the design and calibration of the Pillar 1 leverage ratio, the use of risk-weighted capital floors based on standardized approaches and a review of the existing regulatory treatment of sovereign risk.

While the U.S. banking agencies have demonstrated their commitment to generally implementing the various internationally agreed-upon Basel Committee frameworks9 (and often going above and beyond international requirements with so-called “super-equivalent” rules such as the U.S. G-SIB surcharge framework10 and the enhanced supplementary leverage ratio11), it remains to be seen if, when and how these revised frameworks, once finalized, may be implemented into the U.S. regulatory capital rules, including in how such rules may interact with other U.S. legal requirements such as the Collins Amendment – Section 171 of the Dodd-Frank Act.