Late last year, we sent clients in-depth analyses of the proposals that combine to create a new Basel IV framework even though Basel classifies them as only revisions to the current standards for credit, operational, and market risk. Markets are already reflecting our conclusions, pricing the prospective cost of changes into strategic planning, especially when it comes to M&A and business-line restructuring. Traditional banking activities – residential and commercial mortgages, corporate finance – are hit particularly hard, but other key business lines – asset management and broker-dealer operations – would similarly be substantively restructured. Key issues to consider include:
- Changes to the zero risk weighting for sovereign obligations will have spill-over effect to other assets and increase the cost of investment portfolios, a particularly challenging issue given the new liquidity rules and their requirements to hold more sovereigns.
- A new floor for risk-based capital diminishes the risk sensitivity of the capital rules, aligning them better with the leverage requirements but increasing pressure to reduce holdings of low-risk assets that become uneconomic under the new framework.
- Obligations to other financial institutions bear heightened cost, reducing inter-connectedness but also adversely affecting liquidity and increasing reliance on non-bank liabilities.
- Major changes to off-balance sheet and repo capital are under consideration, increasing pressure here as the NSFR is finalized.
- Asset management and broker-dealer operations bear considerably higher capital costs, as with custody banking and overall trading operations. Coming in concert with SEC leverage rules for broker-dealers and other changes contemplated by the FSOC, this sector in the U.S. faces major new regulatory risk.
- Significant market-liquidity pressure already evident due to regulatory factors will increase absent development of non-bank liquidity facilities or greater reliance on collateral transformation.
To be sure, the Basel IV framework is only proposed and far from final in critical respects (e.g., treatment of sovereigns, asset management). Markets are, however, already pricing it, making forward-looking analytics critical not only to effective advocacy as these standards advance, but also immediate corporate planning.
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