Basel 3.13.1

The Basel 3.1 standards aim to strengthen the risk-sensitivity of RWA calculations and address the degree of variability observed by the Basel Committee on Banking Supervision (BCBS) in firms’ calculation of RWAs, especially those using internal models. The changes will improve the comparability and credibility of firms’ risk-based capital ratios.

In particular, the proposals would advance the PRA’s primary objective by:

• Streamlining and narrowing the variety of methods for RWA estimations, which fosters uniform methodology application across companies via simpler and more transparent guidelines;
• Enhancing the risk awareness of Standardized Approaches within the capital structure, leading to RWAs that better represent the actual risks for firms employing these methods;
• Restricting the employment of Internal Model approaches in scenarios where robust and cautious modelling of RWAs is unachievable, to mitigate undue RWA fluctuation; and
• Establishing a minimum threshold, which sets a limit on how much the internally-modelled RWAs can deviate below the figures generated through the updated
• Standardized Approaches, thereby minimizing extreme variability and cyclicality in RWAs

Basel 4: The term “Basel IV” is often used informally for the above Basel 3.1 reforms. There is no separate, official Basel IV standard.

How Basel 3.1 Differs from CRR3:

• Scope: Basel 3.1 guidelines are set by the Basel Committee on Banking Supervision (BCBS) and provide a global framework.
• CRR3: CRR3 (the third iteration of the Capital Requirements Regulation) is the specific European Union (EU) implementation of the Basel 3.1 recommendations.

Key Differences between Basel 3.1 and CRR3:

• Output Floors: CRR3 introduces output floors, restricting how much banks can reduce their capital requirements using internal risk models. These are more stringent than the BCBS guidelines.
• Transitional Arrangements: CRR3 includes longer transitional periods for specific elements like unrated corporates and derivatives when calculating the output floor.
• Credit Risk Approach: CRR3 removes the requirement for the Advanced Internal Ratings-Based (A-IRB) approach for exposures to certain asset classes, instead mandating the Standardized Approach (SA).
• Important Note: Regulations are complex and can change. It’s always best to refer to official PRA and EU documentation for the most up-to-date and authoritative information.

Key Areas of Differences between Basel 3.1 PRA Implementation & EU:

• Output Floor
  PRA: The UK has adopted the full Basel 3.1 output floor of 72.5%. Banks cannot have risk-weighted assets (RWAs) calculated through internal models that fall below 72.5% of the RWAs calculated via the standardized approach.
  EU: The output floor is likely to be implemented, but EU member states have some flexibility in setting it below 72.5%. This could result in less stringent capital requirements in some countries.
• Leverage Ratio
  PRA: The UK is adopting a minimum leverage ratio of 3%, with an additional buffer of 2.5% for G-SIBs (Globally Systemically Important Banks).
  EU: While a leverage ratio is included in the EU’s approach, national authorities have flexibility in setting the buffer requirements, potentially leading to lower requirements for some banks
• NSFR (Net Stable Funding Ratio)
  PRA: The PRA is adopting the NSFR as proposed in Basel 3.1. This focuses on long-term liquidity health.
  EU: The EU is also expected to adopt the NSFR, ensuring banks maintain sufficient stable funding sources.
• Emphasis on Supervisory Review (Pillar 2) and Market Disclosure (Pillar 3)
  Both PRA and EU: There’s a consistent emphasis on robust Pillar 2 supervision, allowing regulators to tailor additional capital requirements based on a bank’s specific risk profile. Additionally, both follow Pillar 3’s push for transparency and disclosure.

Why the Differences Matter:

• Competitiveness: The PRA’s stricter stance, particularly on the output floor, could increase capital costs for UK banks. There’s a concern that this puts them at a competitive disadvantage compared to EU counterparts potentially subject to lower capital requirements.
• Level Playing Field: The asynchronous implementation (EU rules coming into effect later), along with regional variance within the EU, raises concerns that there won’t be a true level playing field for some time.
• Financial Stability: While the PRA and EU are trying to strengthen financial stability, the PRA’s slightly stricter approach could arguably offer a slightly greater safety net.

In Summary, the PRA largely aligns with the Basel 3.1 framework, with a few stricter interpretations. The EU takes a broadly similar approach but allows more national discretion, potentially leading to less severe capital requirement increases for some banks.