European Banks: Navigating Basel 4

GICP expert view / 19 December, 2024

Basel 4 (also known as Basel 3.1) aims to capture risk more accurately and reduce variability in risk-weighted asset (RWA) calculations, focusing on credit, market, and operational risks. ‘European Banks: Basel 4 /CRR 3 Primer’ from CreditSights provides an overview of Basel 4 alongside its implications for, and impact on, European banks.

The package of reforms within Basel 4 will be implemented in the EU from January 2025 through amendments to the Capital Requirements Regulation (CRR 3) and Capital Requirements Directive (CRD 6). The transition period extends until January 2030, with the transition period for the output floor on mortgage loans and risk weights on loans to unrated corporates extended to 2032. The UK, Switzerland, and the US will implement similar amendments with slightly different timeframes.

A significant change within Basel 4 is the introduction of an output floor, designed to limit the benefit banks can gain from using their internal models to calculate RWAs. Specifically, the output floor sets a floor for RWAs calculated by internal models at 72.5% of those calculated using the standardised approach. This measure will particularly affect residential mortgage loans.

The Danish Compromise will continue, allowing banks with insurance subsidiaries to risk-weight their holdings rather than deduct them from own funds, with risk weights reducing from 370% to 250%.

Other changes, not yet finalised in some jurisdictions, include the final implementation of the fundamental review of the trading book (FRTB) and a new standardised measurement approach for operational risk, both of which look set to increase market risk RWA and/or operational risk RWA for a number of banks.

However, generally the estimated increase in banks’ RWAs and the consequent increase in capital requirements is much lower than the initial expectations. The European Banking Authority now estimates that the Tier 1 capital requirements for EU banks will rise by 9.9%, while the UK's Prudential Regulatory Authority now estimates an increase of less than 1% for UK banks once the reforms are fully implemented.

You can view the full primer, which includes details on the capital impact estimated by key European banks, here. Please note that a CreditSights subscription will be required to access the report.