Proposed Basel III Regulatory Changes: Impact on US Banks

The proposed modifications to the Basel III framework aim to enhance the resilience of smaller banks in the United States by introducing more stringent capital requirements. These changes primarily affect Category III and IV banks, which have less stringent requirements compared to larger institutions (Category I and II).

Key Modifications

1. Changes to Netting

• The proposal removes the ability to net secured transactions with unsecured exposures within a securities borrowing and lending netting set.
• This means that banks will be required to treat these exposures as unsecured, potentially increasing capital requirements.

2. Removal of Simple Transparent and Comparable (STC) Securitization Criteria

• The proposed regulations eliminate the STC criteria for securitization exposures.
• This would subject all securitization exposures to the standardized approach (SEC-SA), which has a lower risk weight floor than the previous framework.

3. Cross-Defaulted Exposures

• The proposal expands the definition of defaulted exposures, indicating that borrowers in default with “any” other creditor would trigger defaulted risk weight treatment.

4. Changes to Look-Through Approaches for Equity Investments in Funds

• The proposed regulations remove the simple modified look-through approach (SMLTA) and modify the alternate modified look-through approach (AMLTA) and full look through (FLTA) approaches to include additional factors, such as off-balance sheet exposures held by an investment fund.

5. Removal of Non-Significant Equity Investments (NSEI)

• The proposal eliminates NSEI from the simple risk-weight approach (SRWA), which would have a material impact on equity regulatory capital requirements.

6. Standardized Approach for Counterparty Credit Risk (SA-CCR)

• All banks, including Category III and IV institutions, would be required to use SA-CCR for calculating counterparty credit risk, adding significant implementation complexity.

7. Tailoring of Capital Requirements

• The proposal reverses the tailoring of capital requirements for smaller banks (Category III and IV), effectively merging the four categories when it comes to capital requirements.

8. Accumulated Other Comprehensive Income (AOCI) Opt-Out Removal

• Category III and IV banks would no longer be able to opt-out of recognizing unrealized gains and losses on available-for-sale securities in calculating their regulatory capital through AOCI.

9. Higher Capital Deductions

• The proposal introduces more punitive deduction requirements for threshold items, such as mortgage servicing assets, temporary difference deferred tax assets, and significant investments in the capital of unconsolidated financial institutions.

10. Inclusion of Minority Interests in Capital

• Category III and IV banks would be required to include minority interests in their capital, potentially increasing their regulatory capital requirements.

11. Requirement to Use SA-CCR for Single Counterparty Credit Limits (SCCL)

• All banks, including Category III and IV institutions, would be required to use SA-CCR for calculating SCCL.

Conclusion

The proposed changes aim to strengthen the resilience of smaller banks by introducing more stringent capital requirements. However, they also increase regulatory complexity and may require significant adjustments in banking operations, risk management, and financial reporting. As these changes are implemented, it is essential for Category III and IV banks to carefully review and adapt their strategies to ensure compliance with the new regulations.