The use of banks’ own internal models to calculate their RWA will be limited under the new rules.
Banks will have to comply with the Basel Committee for Banking Supervision's new rules on how to calculate risk-weighted assets (RWA). These are banks’ loans and other exposures weighted by risk. The RWA are used to calculate the amount of capital the bank must hold for each type of asset. According to PwC, these Basel IV rules mark the conclusion of work carried out by the BCBS to deal with the aftermath of the global financial crisis of 2007-08.
“These reforms are important because they affect all banks globally, regardless of size or business model,” says Emily Lam, Financial Services Risk and Regulatory partner, PwC Hong Kong. “But how they are applied varies a lot from bank to bank. Some may have to carry 10-15% more capital, while others may even see a reduction in RWA.”
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Under the new rules, the use of banks’ own internal models to calculate their RWA will be limited. At the same time, the standardised approaches used by most banks worldwide will become more risk-sensitive and will reflect developments in global financial markets over the last few years. A relatively high capital floor (at 72.5%) to internally-modeled RWA is introduced. The overall aim is to re-establish trust in banks by making it easier to compare their RWA.
“The impact of Basel IV will vary from country to country, depending on local lending practices,” said Ms Lam. “Larger banks are likely to focus on the changes to their capital floors. Smaller banks may need to look at infrastructure and technology investments because of the volume and granularity of data they will need to handle as part of these standardised approaches.”
This new package of rules will be introduced globally with a ‘big bang’ in 2022. In the interim, national lawmakers will need to draft new legislation to reflect the rules and many businesses will need to adjust their strategies. If a bank’s capital costs increase, this will affect the interest rates and fees it charges its clients. If some business areas no longer prove attractive to banks, other players – such as insurance companies, asset managers, hedge funds or FinTech businesses – may step in.
“While the proposed implementation timeline may seem to stretch further into the future, it is imperative for all banks to take action now,” said Brian Yiu, Financial Services Risk and Regulatory partner for PwC Hong Kong. “We welcome the fact that there is now clarity about the new regulations. But banks are going to need significant time and resources to adjust to the new reality and implement all the necessary changes.”
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