Basel: No deal on output floor

  • By Elizabeth Fry

Global banking regulators have failed to agree on a critical aspect of the Basel IV suite of reforms - the so-called output floor that curbs the extent to which banks can use their own models to work out the riskiness of their loan books.

Yet, at an Institute of International Finance dinner held in Washington DC during the weekend, William Coen, secretary general of the Basel Committee, reassured members that a deal is close and urged IIF members not to be discouraged.

With the bulk of the post-crisis Basel reforms completed, the output floor is the only real sticking point.

In essence, the output floor limits the extent to which the big banks can use their own risk modelsto calculate the riskiness of their lending.

The floor, in effect, prevents them from calculating capital requirements that are too far below those calculated through a standardised model, set by regulators.

Global regulators say there are big differences in how much capital banks set aside to cover the same risks.

As Coen pointed out to the audience, regulators think either that the final standard is too stringent or that it is not stringent enough.

An uphill finish

Now, I think we're almost there,”Coen argued.

"In the past few months, we have labored to get up and over this last hill, otherwise known as the capital output floor.

“I think of it as a steep, uphill finish,” he said.

In those last few metres of a marathon, he went on to say, with the finish line in sight, it’s fairly clear what the result will be.

Coen told his audience that he often hears that “no deal is better than a bad deal but that he disagreed with that view.

“No deal means that we have not finished the job and that we have failed to lay the groundwork for more resilient banks and a more stable banking system.

“Further, that we have missed an opportunity to restore the credibility of risk-weighted capital ratios.

"If we stop now, we will not have satisfactorily addressed the thorny issue of unwarranted variability in risk-weighted assets."

Issue with RWA

Indeed, he argued, it is clear RWA compression continues in some cases even though risks have not really been scaled back.

The list of reforms may seem very long, and banks, for their part, have made significant progress to correct deficiencies laid bare by the crisis, according to the Committee head.

“When runners hit the wall, they feel a seemingly insurmountable wave of fatigue and doubt whether they have the energy or even the will to continue.

"I think it is safe to say that all of us, both industry and regulators, have experienced something like this.

“Once you’ve pushed through the pain and fatigue, you sense that the finish line beckons.”

The Committee wants to calibrate the floor at 70 to 75 per cent of a bank’s risk-weighted assets that would apply had it used regulators’ standardised models for measuring risk.