Credit risk RWAs could prove challenging under Basel III rules, says ISLA
13 June 2023 UK
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The International Securities Lending Association (ISLA) has published an overview of the Basel III framework, its impact on the securities finance market and how to address upcoming challenges.
Basel III is a set of international standards developed by the Basel Committee on Banking Supervision (BCBS), which produced a framework of measures to strengthen the supervision and risk management of banks.
The Basel III framework reforms took effect from 1 January 2023 and look to impact banks engaged in securities financing activity. In most instances, banks will now need to allocate more capital to support these activities, according to ISLA.
The Prudential Banking Rules: Explanatory Note published by ISLA reveals that credit risk risk-weighted assets (RWAs) under the Output Floor, as well as minimum haircuts for securities financing transactions under the Basel III reforms, could prove challenging for the industry.
For credit risk RWAs, ISLA observes, the challenge presented to the market is the “potentially significant and disproportionate increase” in the amount of capital banks need to hold under the Output Floor for credit risk in relation to their securities borrowing activity.
According to the Explanatory Note, the counterparty risk weights for most principal lenders under the standardised approach used in the Output Floor increase from low numbers today — typically around 10 per cent under the internal ratings-based (IRB) approach — to 100 per cent, alongside other increases in RWAs for banks at the same time.
ISLA believes that the proposed treatment of exposures to unrated low-risk counterparties could have an adverse impact on the global securities lending market.
The Output Floor for RWA will be phased in over a five-year period, through transitional arrangements until 1 January 2028.
The Output Floor is a measure that sets a lower limit (floor) on RWAs based on the revised standardised approaches in the framework, therefore limiting the benefit banks can obtain from their use of internal models to measure credit risk and market risk RWAs. This aims to reduce unwarranted variability and increase the comparability of capital ratios of banks using internal models.
However, some jurisdictions have accelerated the timeline for the Output Floor for RWA, while others are planning their implementation on a later timeline.
Basel III is a set of international standards developed by the Basel Committee on Banking Supervision (BCBS), which produced a framework of measures to strengthen the supervision and risk management of banks.
The Basel III framework reforms took effect from 1 January 2023 and look to impact banks engaged in securities financing activity. In most instances, banks will now need to allocate more capital to support these activities, according to ISLA.
The Prudential Banking Rules: Explanatory Note published by ISLA reveals that credit risk risk-weighted assets (RWAs) under the Output Floor, as well as minimum haircuts for securities financing transactions under the Basel III reforms, could prove challenging for the industry.
For credit risk RWAs, ISLA observes, the challenge presented to the market is the “potentially significant and disproportionate increase” in the amount of capital banks need to hold under the Output Floor for credit risk in relation to their securities borrowing activity.
According to the Explanatory Note, the counterparty risk weights for most principal lenders under the standardised approach used in the Output Floor increase from low numbers today — typically around 10 per cent under the internal ratings-based (IRB) approach — to 100 per cent, alongside other increases in RWAs for banks at the same time.
ISLA believes that the proposed treatment of exposures to unrated low-risk counterparties could have an adverse impact on the global securities lending market.
The Output Floor for RWA will be phased in over a five-year period, through transitional arrangements until 1 January 2028.
The Output Floor is a measure that sets a lower limit (floor) on RWAs based on the revised standardised approaches in the framework, therefore limiting the benefit banks can obtain from their use of internal models to measure credit risk and market risk RWAs. This aims to reduce unwarranted variability and increase the comparability of capital ratios of banks using internal models.
However, some jurisdictions have accelerated the timeline for the Output Floor for RWA, while others are planning their implementation on a later timeline.
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