Splintering of the international capital framework?

Capital requirements have long been relegated to the "someone else can think about it" category for the majority of the financial services industry. Until, that is, the Basel Endgame (as it has been dubbed in the US - elsewhere in the world the reforms are known as the Basel III Final Standards or Basel 3.1).

Since July 2023 there has been loud, public and visceral pushback on the implementation of the Basel Endgame in the US – with billboard advertisements opposing the rules popping up all over America. Concerns relate to increased capital requirements that, if applied, are expected to negatively impact everyday voters - particularly low-income and first-time house buyers.

But why does the US position matter to the rest of the world?

The Basel framework sets out international standards for bank regulation: the first was the Basel Concordat in 1975, but its landmark publications are the Basel I, Basel II and Basel III accords on capital adequacy (with Basel III being published in December 2010, reflecting lessons learned from the 2008 financial crisis). These accords aim to align international bank supervision and regulation - and ultimately have provided the bedrock for the international regulation of banks. International banks are (generally) only subject to capital requirements in their "home" country while conduct rules apply depending on "host" country rules. This international agreement means that banks are only subject to one set of capital rules and jurisdictions across the world can be comfortable that a familiar level of supervision and regulation applies.

What is Basel 3.1/Endgame?

The Basel 3.1 package is the final set of reforms designed to address the concerns identified following the 2008 financial crisis. It aims to close all potential loopholes to the rules. The package focuses on risk weighted assets (or RWAs) (for example, loans made to customers) that are used to calculate the ratio of capital instruments that must be held by a bank and ultimately ensure that the bank can withstand losses.

The existing Basel capital framework allows banks to use their own internal models to calculate risk weighted assets (so called internal rating based (IRB) models) rather than use the standardised approach set by regulators. In practice, this has resulted in significant differences in how banks are calculating their capital requirements (although some commentators consider that these divergent approaches could also be attributed to differences in the supervisory approach to capital requirements, even within the EU, where efforts in 2021 largely addressed concerns before Basel 3.1 implementation).

Basel 3.1 aims to restrict internal models and restore faith in the framework and calculation of risk weighted assets.

There are variations in the approach taken by different jurisdictions across the world to implementation of the Basel requirements (which are minimum standards), with many choosing to "gold-plate" them (impose higher standards). This means that the levels of bank regulatory capital required continue to vary jurisdiction by jurisdiction, particularly depending on the bank's size. So, for example, while the EU has applied the Basel framework to all banks, the UK is looking to take a more proportionate approach with small domestic deposit takers subject to a less onerous regime under the so-called "Strong and Simple" capital regime for smaller banks. The US' original 2023 approach to the Basel Endgame would have required significantly increased capital levels for banks holding US$100 billion or more in assets.

Where are we now? And what's to come?

A number of jurisdictions have progressed with implementation of Basel 3.1 (including Australia, Canada, China and Japan – although some jurisdictions have transitional arrangements), but the uncertainty around implementation timelines in jurisdictions with many internationally active banks (particularly the US) remains very high and further delays are expected or have been confirmed.

In this context, both the EU and UK have delayed implementation to see how the US approach settles.