The final Basel 3 reforms cross the Swiss finishing line at last

FINMA has just published the ordinances for the final implementation of Basel 3. This will change the ways banks calculate their capital requirements for credit risk, market risk and operational risks. What will be the impacts on banks?

A few significant changes in the last version of the ordinances
On Wednesday, 27 March 2024 FINMA published the last missing pieces of the puzzle in the implementation of the final version of Basel 3 (B3) in Switzerland. All the new rules will be applicable from the 1st of January 2025.

The changes to the Basel text introduced by the Swiss regulators are intended to enhance the competitiveness of the Swiss banking system. Some important changes were made in the final version of the ordinances, such as the removal for now of minimal haircuts for some securities financing transactions (SFTs) and better adjustment of capital requirements for the risk relating to collective assets in the trading book. Simplifications are available for category 4 and 5 banks, and for some category 3 banks, if their activities and positions are not significant.

The impacts of the new rules will vary and depend on the type of risk. For market risk, capital requirements are likely to increase for banks with large trading books using the internal model approach. Trading and banking book will be subject to stricter delimitation and the standardised approach will have to be used for more of the portfolio. The changed rules for credit risk should not result in large increases in capital. Within credit risk requirements for standardised approach, it is important to note that overall requirements for mortgages are expected to decrease, but they will increase for higher loan-to-value (LTV) mortgages and buy-to-let mortgages. Risk Weighted Assets (RWA) are also likely to increase for low-rated corporates. For operational risk the change to a uniform standardised approach and ending of the modelled approach might increase the capital requirements for a limited number of Swiss banks.

A survey: what is the impact on capital requirements?
In the second half of 2023, Deloitte conducted a survey of Swiss banks1 to reveal their key areas of focus and challenges associated with the implementation of Basel 3 final, and also gathered additional insights from clients’ conversations.

Most surveyed banks expect the impact of the finalisation of B3 on their capital requirements to be generally mild, with their capital ratio decreasing by 0.5% or 1%. However, several private banks anticipate a bigger impact before any adjustments, with their capital ratio declining by 2-3%.

Credit risk is the most important factor in this, with the treatment of Lombard loans, mortgages and Private Equity increasing the capital requirements. Some banks with sizeable trading portfolios may see an even bigger impact on their market risk capital requirements as the fundamental review of the trading bank (FRTB) changes is capital-intensive for leveraged products. By contrast, banks using internal model approaches for credit risk might see a positive impact thanks to the removal of the scalar in the internal ratings-based (IRB) approach.

Regardless of those impacts, few surveyed banks foresee changes to their business mix as a result of the finalisation of B3.

The implementation effort will be significant for many
Even if the finalisation of B3 won’t trigger massive capital increases, there will be costs associated with it. Banks see the effort required to implement the changes as being quite high. On a 10-point scale, two thirds of surveyed banks estimate their required level of effort at 6 or 7. Only 20% of respondents expect the effort required to be limited, rating it at 3 or 4 out of 10.

Three areas appear to present significant challenges:

• The availability and quality of data, as the standardised approach for credit risk requires more granular data due to its more risk-sensitive nature, and the new standardised approach to operational risk obliges a significant effort to gather historical loss data.
• Changes to systems, to accommodate the new data needs and make sure management information and regulatory reporting are adjusted to reflect the new regulatory context.
• Interpretation of the new regulatory text as there is lack of detailed guidance in a few areas, such as the conditions underlying the market risk approach (standard vs simplified), ratings due diligence materiality thresholds, and the monitoring needed for having a 0% credit conversion factor (CCF) for revocable lines.

Work to implement the regulatory changes has already been launched by most of the banks participating in the survey. However, more than a third are just at the beginning of the process.

Risk management stands to benefit
The changes triggered by the finalisation of Basel 3 can also have a positive impact in terms of processes and transparency. Most respondents expect an improvement in their data quality and better comparability of solvency ratios between banks. A few banks have also mentioned that the more risk-sensitive final B3 standardised approaches will allow regulatory ratios to better reflect risk and the way it is managed in banks’ internal risk management frameworks. They will therefore become more than just a formal exercise.
Banks should therefore see this update of the capital adequacy framework as an opportunity to upgrade their RWA monitoring system and improve their data quality, making for enhanced risk management.

1These banks are a mix of cantonal banks, private banks, and corporate banks, with two thirds of category 3 banks.

Authors

• Alexandre Buga - Partner, Audit & Assurance, Financial Services
• Hortense Huez - Director, Audit & Assurance, Financial Services