Basel IV – Challenges & Opportunities

1 June 2016

By Bruno Deletré, Director General, Crédit Foncier de France & Chairman of the European Mortgage Federation (EMF)

“Basel IV” is the term that is being widely used to refer to a series of new measures from the Basel Committee on Banking Supervision (BCBS) to enhance methods banks must use to calculate risk and therefore how much capital they should set aside. Key changes are being made in relation to credit risk, operational risk, market risk, and large exposures.

The reforms to the calculation of credit risk, which include a new standardised approach, limits on how banks calibrate IRB models and possibly new floors, will almost certainly represent a game change for the mortgage and covered bond industries in terms of minimum capital requirements and disclosed capital ratios. The BCBS has repeatedly assured the market that it has no intention of significantly increasing overall capital requirements; however, if the conservative nature of the calibration of the proposals so far are anything to go by, there is a real risk that there will be a significant additional tightening of capital requirements.

With the potentially significant impact of the new regulatory landscape on the mortgage industry in mind, the EMF-ECBC has been analysing the revisions from both funding and origination perspectives and has been developing a coordinated approach in examining and responding to all consultation papers published by the BCBS and the European Institutions.

Most recently, the EMF-ECBC responded to the second BCBS consultation on the revision to the standardised approach. In this second version, although improvements have been made, there are still a number of proposals of significant concern for the mortgage and covered bond industries. The EMF-ECBC highlighted the following key points in its official response to the consultation in March 2016:

  • Given the diversity of global real estate (RE) markets in terms of risk profile, a one-size-fits-all approach is not appropriate.
  • There should be consistency between risk weights across different exposure classes, so that secured exposures are not penalised compared to unsecured exposures.
  • The proposed risk weights lead to significantly higher standardised approach capital charges for higher LTV loans. Loan splitting could help limit this impact and avoid threshold effects that would trigger regulatory arbitrage in the future.
  • A more balanced approach is needed for Income Producing Real Estate as there is no evidence that cash flow producing real estate is generally riskier exposure.
  • A fine-tuning of operational requirements is needed with regards to recognition of guarantees and financial collaterals, and valuation basis and frequency.
  • The standardised approach and capital floors consultations should be seen together because the capital floors will be based upon the standardised approach.

With regards to the last point it is important to mention that the impact of floors on the capital charge could be significant. A 60-90% output floor for IRB banks, as suggested by the Basel Committee in the IRB consultation, would be of great concern. The EMF-ECBC is currently examining the IRB consultation with a view to delivering its comments by the June 2016 deadline.

It has been suggested in the press that Basel IV could cost the world’s largest banks some €115 billion in extra capital and that European banks would bear the brunt of the new costs coming from the BCBS: around €70 billion of the total. As a consequence, there seems to be a consensus across many and relevant jurisdictions on the need to limit the increase of risk weights, for instance by allowing loan splitting. We are glad to see that on arguably the most important issues several global regions are very much aligned.

“Given the diversity of global real estate (RE) markets in terms of risk profile, a one-size-fits-all approach is not appropriate.”

Basel IV is not the only regulatory concern on the Industry’s radar. The calibration of the leverage ratio (LR) and of the net stable funding requirements (NSFR) at EU level are of the utmost importance too. The European Commission is expected to announce its intentions with regard to both by the end of 2016. The EMF-ECBC has already commented extensively on both files and has been in regular dialogue with the European Commission and European Banking Authority (EBA). Recent and expected developments at EBA level – i.e. the publication of its NSFR Report in December 2015 and the forthcoming publication of its LR report, expected in July 2016, have resulted in an updated EMF-ECBC Position Paper on the NSFR and will prompt further internal considerations on the LR (watch this space for an updated EMF-ECBC Position Paper on this file too).

The EMF-ECBC is playing the role of a discussion forum here and acting as a catalyst by trying to analyse and increase awareness of the potential impact of the measures under discussion, as well as to take the lead in proposing pan-European market initiatives which could ensure financial stability and market due diligence. In this context, on the 3rd of June 2016, the EMF-ECBC will bring together its decision-makers, in the form of its Executive and Steering Committees, with senior representatives of the BCBS and the European Commission to exchange views on the challenges of the ongoing and upcoming regulatory changes for the mortgage and covered bond industries.

The panel will also consider a current EMF-ECBC initiative, a solely market initiative, to bring energy efficient mortgages to borrowers on a mainstream scale, which will deliver micro-economic benefits to all of the actors in the chain: borrowers, lenders, investors, governments etc. in terms of wealth conservation, risk mitigation, capital relief and energy savings – a “win-win” situation. We believe that dialogue amongst stakeholders will play a pivotal role. Exchanging views on the current challenges and opportunities is a constructive way to pave the way for the future of the mortgage and covered bond industries in Europe. We are all aware that more has to be done and we are ready to contribute to growth and financial stability by securing the European approach to banking in the current global debate on the future of the financial system.

We will be posting regular updates on this initiative in future editions of our newsletter and also on our blog, so keep an eye open for the latest news!

This article was originally published in the EMF-ECBC  Market Insights & Updates newsletter in May 2016. Please note that any views or opinions expressed in this article are those of the authors and not necessarily those of the EMF-ECBC. This article does not constitute investment advice.