As a response to flaws in the regulatory framework, which were exposed during the financial crisis, a myriad of measures have been initiated by various supervisory and standard setting bodies with the aim to strengthen the stability of the financial sector.
One of the most important initiatives has now been concluded: on 7 December 2017, the Basel Committee’s oversight body, the Group of Central Bank Governors and Heads of Supervision, has finalised the Basel III post-crisis regulatory reforms, also referred to as Basel IV.
Several revisions have been made to the standardised approaches that are part of Pillar 1, for example to the ones dealing with credit risk and operational risk. Other changes concern the internal ratings-based approach, the credit valuation adjustment framework and the measurement of the leverage ratio.
In general, most changes restrict the degrees of freedom with respect to the use of internal models. The convergence of internal models is desired by the BCBS to rebuild the confidence that the financial sector has a sufficient capital base. Also the Targeted Review of Internal Models (TRIM) fits this ambition.
Another change, the introduction of an aggregate output floor, is particularly relevant for Dutch banks. According to the final Basel III requirement, banks cannot assign an RWA-weight (stemming from an internal model) that is less than 72.5% of the RWA as calculated by Basel III’s standardised approaches.
Typically, this floor results in a much higher RWA for retail mortgage portfolios than currently applied by Dutch banks. DNB estimates that Dutch banks suffer from a EUR 14 billion capital shortfall based on the total Basel III package. Further discussions are expected to take place on this requirement, as the Basel III framework still needs to be transposed into European law.
The revised standards will take effect from 1 January 2022 and they will be phased in over a five year period ending in 2027.