The Basel IV Accords were introduced as an extension of the previous Basel Accords (I, II, and III) with the objective of further strengthening the resilience of the banking sector to crises. The main aim of Basel IV is to close the loopholes in the Basel III rules, which were introduced after the 2008 financial crisis, and to limit excessive variations in the methods used to calculate Risk-Weighted Assets (RWA).

The agreements were finalized in 2017 and are being implemented in phases with the objective of mitigating the risks of regulatory arbitrage and standardizing capital requirements between banks. The primary challenges are as follows:

  • – Improve the transparency and comparability of banks’ solvency ratios.
  • – Restrictions on the use of internal models to calculate RWA, which had allowed some banks to artificially reduce their capital requirements.
  • – Implement more conservative standards to better cover credit risks.

 

The implementation of Basel IV has been phased in to allow banks to adapt to the new requirements:

  • – 2017: Basel IV rules finalized.
  • – 2023: Originally planned start date for capital requirements (postponed to 2025 because of the COVID-19 pandemic).
  • – 2025: Implementation of the output floor, which sets a floor for RWAs of banks using internal models of at least 72.5% of RWAs calculated using the standardized approach.
  • – 2028: End of the transition period for the output floor.

 

Basel III rules and changes introduced by Basel IV

Basel III

The Basel III rules, introduced in 2010, were designed to strengthen the resilience of the banking sector. They introduced:

  • – Increase capital requirements: Increase in capital ratio to a minimum of 4.5% CET1 and 8% Tier 1.
  • – Leverage ratio: Introduction of a minimum leverage ratio of 3%, limiting the ability of banks to accumulate assets in excess of their capital.
  • – Prudential and countercyclical buffers: Creation of buffers to absorb losses in times of crisis.
  • – Liquidity ratios: Two liquidity ratios, the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR), to ensure that banks have adequate liquidity reserves and are less dependent on short-term funding.

 

Basel IV

Basel IV retains the fundamentals of Basel III but introduces a number of significant changes, including:

  • 1. Limit on internal models: The introduction of a 72.5% output floor means that a bank’s RWA cannot fall below 72.5% of the RWA calculated using the standardized approach, thereby limiting the significant variation arising from internal models.
  • 2. Standardization of RWA calculation: A revision of the methods for calculating RWAs in several asset classes. The standardized method will become more risk sensitive, with weightings adjusted for different types of credit risk (e.g. real estate, SMEs).
  • 3. Consolidation of solvency ratios: Basel IV maintains the requirements of Basel III, but strengthens the monitoring and transparency of solvency ratios.

 

What are the consequences for banks?

The new rules require banks to hold more capital against certain types of risk, which may reduce their profitability, especially if they use sophisticated internal models to assess risk. On the other hand, this standardization of requirements helps to increase the stability of the banking sector by making capital ratios more consistent and comparable across institutions.

How can banks meet these new requirements?

To comply with the Basel IV rules, banks should take a number of practical and strategic steps to adjust their risk models, capital and internal processes. Here are some examples of actions that could be taken:

1. Adaptation of risk calculation models

  • Review of internal models: Banks that use internal models to value their risk-weighted assets (RWA) will need to adjust these models to comply with the 72.5% output floor. This means that, in some cases, they will have to adopt a standardized methodology for certain risk portfolios.
  • Adoption of standardized approaches for certain portfolios: In order to comply with Basel IV, some banks may choose to abandon internal models for certain specific assets and adopt the standardized approach, which will be more consistent with the new requirements.

 

2. Strengthening governance and capital management

  • Building capital buffers: Banks must ensure that they have sufficient capital to meet the increased requirements associated with the output floor and changes in risk weights. This may require an increase in capital or a reallocation of assets to reduce their risk profile.
  • Adjustment of dividend policy: In order to accumulate more capital, banks may adjust their dividend policy and limit payments to shareholders in order to strengthen their reserves.

 

3. Portfolio optimization and asset reallocation

  • Reallocation of risky assets: Banks will need to re-evaluate their assets to reduce exposures that are too risky or result in high-risk weights under the new rules. This could lead to changes in lending strategy, in particular by focusing on portfolios with lower risk weights (e.g. SME loans, residential mortgages).
  • Reducing risky exposures: By reducing exposure to risky sectors or customers, banks can reduce their capital requirements.

 

4. Modernizing systems and data

  • Upgrading risk management systems: The new Basel IV requirements imply better quality data for calculating RWAs. Banks will need to invest in systems capable of processing accurate and consistent data, with enhanced reporting capabilities.
  • Improved data quality: Calculating RWAs using the standardized approach requires very detailed data, particularly on the nature of assets, collateral, size and sector of counterparties. This requires efforts to collect, cleanse and integrate data into risk management systems.

 

5. Strengthening internal controls and reporting

  • Improve internal controls: Banks need to strengthen their control processes to verify data accuracy and compliance with Basel IV rules. This includes increased monitoring of RWA calculations and capital allocation.
  • Improve reporting capabilities: Basel IV requires regular and detailed reporting to regulators, requiring banks to implement enhanced reporting tools to monitor capital requirements and risk allocation.

 

6. Staff training and awareness

  • Raise awareness of new rules: Bank teams, particularly those in risk management, finance and compliance, need to be trained in the new rules and understand how they will impact the business.
  • Capital and risk management training: Teams need to be made aware of the impact of Basel IV on credit and capital strategies to ensure that lending decisions are consistent with new capital constraints.

 

What are the implications for Belgian financial institutions?

As a member of the European Union, Belgium is subject to European banking regulations implementing the Basel IV Accords. The National Bank of Belgium (NBB) and the Financial Services and Markets Authority (FSMA) will ensure that Belgian banks comply with these rules. However, the country may sometimes adopt specific interpretations or adaptations depending on its economic and financial context.

The Belgian banking sector is a key player in the country’s economy, with well-established institutions that have a strong local and international presence. These large banks will have to adapt to the increased requirements of Basel IV, which could require significant capital adjustments.

However, they generally have the resources to meet these challenges. For small and medium-sized Belgian banks, particularly those focused on local markets and SME lending, the Basel IV rules could have a greater impact because they are less able to internalize the costs of adjustment. These banks may have to review their approach to risk and capital, in particular to comply with the output floor and the standardization of RWAs.

The Belgian market is particularly active in mortgage lending, which accounts for a large proportion of domestic banks’ assets. The changes in risk weighting in this sector under Basel IV, in particular the adjustment of the criteria for calculating RWAs for mortgage loans, will have an impact on the capital management of Belgian banks. If the rules for these types of assets become stricter, banks may have to reassess their exposure and adjust their real estate lending offer.

SMEs also play an important role in the Belgian economy. Many Belgian banks, especially those focused on regional markets, have significant exposure to the SME sector.

Basel IV, with its stricter requirements on risk-weighted assets, could make it more challenging to provide loans to these companies, particularly if they are perceived as higher-risk. The revision of risk weights could increase the cost of credit management for these segments, which could result in a reduction in lending or more stringent credit conditions for Belgian SMEs.

Consequently, the Belgian banking market must align with the Basel IV requirements, mirroring the approach taken by other European countries while considering its unique local characteristics. Belgian banks will be required to adapt their risk management strategies to align with the revised risk weightings, particularly for mortgages and loans to SMEs, which represent a significant portion of their portfolios.

The standardization of risk-weighted assets (RWAs) and the introduction of the output floor could result in increased capital requirements, leading to higher credit costs, particularly for segments perceived as riskier. Banks will need to modify their risk management strategies, re-evaluate their portfolios, and enhance their capital management systems to comply with the new regulations while maintaining their long-term profitability.

In conclusion, the implementation of Basel IV regulations necessitates a comprehensive reassessment of capital management and risk strategies, with a particular focus on transparency, data precision, and robust risk management systems. While compliance with these rules may temporarily impact profitability, it is expected to enhance resilience and instill confidence in the banking sector over the long term.