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The latest amendments to CRR2 put a final stone to Basel III standards (2010), applicable as of June 2021. Basel IV was lastly changed in 2020, which resulted in the second postponement2 of the implementation period, as a supervisory decisions to the COVID pandemic
As a reminder, Basel IV was designed as complementary to Basel III in order to provide harmonization and standardisation of the capital measurement, to limit the use of internal models, and to define a common level-playing field to foster comparability among peers.
In this context, MLAdvisory is launching several series, which will be communicated between April and June 2021 in order to progressively prepare for the main Basel IV changes.
Key European Stakes
At bank level, what are the nature (capital, organisation, business model) and magnitude of impacts?
Basel IV initially aimed at reviewing Pillar 1 capital measurements. Yet, in Europe, wider impacts are anticipated on business models & profitability3 and on risk & capital management4 (Stress-testing, ICAAP).
How will banks prioritize, allocate and manage their implementation resources in an already “saturated” regulatory context?
The COVID pandemic brought new priorities to the forefront (business continuity & digitalisation) and challenged existing challenges (profitability & Credit Quality monitoring).
We have identified the following key challenges to implement Basel IV in light of COVID: European scenario
Aggregate Output Floor
The aggregate Output Floor limits the use of internal models in the calculation of minimum capital requirements, and serves as a base for the calculation of capital buffers in Europe.
These impacts have been reassessed in light of COVID and of a dedicated European scenario5.
Serie 1: What will be the impacts on banks’ internal models organisation? business models? profitability?
Regulatory Program Management
The enforcement of Basel IV will require the capacity to allocate resources and prioritize implementation in line with parallel on-going requirements.
Serie 2: What are the lessons learnt from the past and how to structure a regulatory program management?
Revised Credit Risk Framework
The revised IRB credit risk framework aims at limiting the variability in RW for a given asset class. This will lead to portfolio migration, added floors on credit parameters and RW increase.
The revised SA Credit Risk aims at improving risk sensitivity and granularity of asset classes. This will lead to more granular asset classes and larger data volumes.
Serie 3: How will banks cope with these changes in parallel of existing Credit road maps (IRB Repair) ?
Standardisation of Op Risk Capital Measure
Op Risk Standardized Measurement Approach is based on a revenue (BIC) and a loss component (ILM). In Europe, implementation of the national discretion (ILM=1) is strongly considered: it would provide for a pure revenue-based measure of Op Risk Capital.
Serie 4: What are the implications for op risk management & monitoring in the aftermath of COVID-19 (lower revenues, new COVID-related losses)?
Beyond Basel IV implementation: Pillar 2 perspectives, complementary series
Capital Management: Pillar 2 and ICAAP
In 2020, the EBA published the updated ICAAP guidelines and provided some guidance on the expectations and key areas of improvement identified at European banking level.
Serie 5: Among the key improvement to be addressed: (i) Data quality and representativity; (ii) Adequation between internal measures and macro-economical context; (iii) Use of stress-testing as a continuous improvement monitoring tool.
The EBA proposal to review the stress testing framework (bank leg / supervisory leg) seems to be on hold, although banks need to strengthen risks coverage for Pillar 2 & ICAAP purposes.
Serie 6: Among the current challenges on stress testing, we chose the following topics for discussion: (i) Inclusion of climate stressed indicators and scenarios; (ii) Severity and plausibility criteria of EBA driven scenarios; (iii) Operational insertion of stress testing (Risk & Finance articulation)