Transition rules unlikely to soften impact from Basel IV

Johan Hansing, chief economist of the industry group the Swedish Bankers' Association, spoke to Nordea Thematics' Viktor Sonebäck (VS) about the implementation of Basel IV from 2025. He believes it will likely increase capital requirements for northern European banks much more so than for US banks. The biggest negative impact looks set to be for unrated large corporate borrowers, with transition rules in 2025-32 likely being generally disregarded by investors and stakeholders, who tend to discount the long term's most strict regulatory outcome.

VS: Could you briefly describe the purpose and mission of the Swedish Bankers’ Association and what your specific role is?

JH: The Swedish Bankers’ Association represents banks and financial institutions established in Sweden. Our aim is to contribute to a sound and efficient regulatory framework that facilitates banks in helping to create economic wealth for customers and society. We also work for a payment infrastructure that functions efficiently, with a special focus on innovation and digitalisation.

As chief economist I am responsible for issues like capital and liquidity requirements, housing loans, crisis management and statistics.

VS: What role can you play regarding implementation of the revised Basel regulations? Coordination between banks in Sweden? Dialogue with relevant regulators? Analysis of potential outcomes of new regulations? Anything else?

JH: Regulations concerning capital requirements have top priority for us, whether they are global, EU-based or national. We have followed Basel IV closely together with our members since the first proposals some ten years ago. Our aim is to identify and influence issues that are of great importance to Swedish banks and the customers of Swedish banks, both households and corporates.

During this ten-year process, we have had regular discussions with Swedish and EU regulators. Since we are members of both the European Banking Federation and the European Mortgage Federation, much of the international lobby activities are undertaken along with these organisations.

For us, it is important to work based on facts. Therefore, we have ordered several impact assessments to clarify the effects on Swedish banks and their customers. All of these impact assessments have shown that Swedish and Nordic banks are among the most affected by the Basel IV proposal.

VS: Do you see a reasonably level playing field for how banks across the world will be affected by Basel IV? Do Nordic banks stand out in some regard? What are some key questions or concerns for Nordic banks?

JH: The consequence of Basel IV is strangely enough that low-risk banks in northern Europe are much more affected than high-risk banks in southern Europe. We can also see that the negative effects, in term of increased capital requirements, are much larger for European banks than for US banks.

The most important explanation for the increased capital requirements for northern Europe banks is the impact of the output floor. A majority of the banks in the region are likely to be restricted by the output floor. This would mean that capital requirements will increase in general and that the calculation of risk weights will be based on standardised measurements rather than the specific risk of each and every customer.

There are mainly two categories of loans affected: housing loans and loans to unrated corporates that are not SMEs. For Swedish banks, the largest impact will be on loans to unrated corporates. If a bank is restricted by the output floor, these loans will have a uniform risk weight that in most cases will be much higher than today.

The effect on Swedish housing loans is more difficult to predict since we already have a national risk weight floor, decided by the Swedish FSA, Finansinspektionen, that will either be kept or abolished once the new rules come into force.

VS: What do you think will be the biggest changes for banks from the implementation of Basel IV? And how will lending to corporates be affected? Impact on availability or pricing?

JH: In December 2021, the EU Commission presented its proposal for implementation of Basel IV in the EU. The proposal is currently being negotiated in the European Parliament and between EU member states.

The most notable elements of the Commission proposal, from a Swedish and Nordic perspective, are the transitional arrangements for mortgage loans and loans to unrated corporates that have low risk. These arrangements mean that the full effect of the output floor will be delayed until 2033. However, such transitional rules are of limited importance since banks, investors and other stakeholders often focus on the long-term situation, assuming the toughest regulatory scenario.

The outcome of the EU negotiations is difficult to predict. Some important EU members have the view that it is important to take EU specifics into consideration for the implementation. One such specific is that corporates are to a much larger extent financed by banks compared to the US, where market financing is dominant. At the same time, many EU members stress the importance of being Basel-compliant in the implementation.

In a worst-case scenario (from a banking perspective), most large banks in northern Europe will be restricted by the output floor. This will, in general, imply increased capital requirements of 10-20% and risk weights that are not based on risk. For the Swedish market, we may see the largest negative effect for stable and low-risk corporates.

VS: Do you think the current proposal for Basel IV will be the final version, or could there be more changes going forward?

JH: The Basel Committee has communicated that its focus will be on the implementation of the final Basel III standard (“Basel IV”) and on “new” areas such as climate-related financial risk and financial stability risk from crypto-assets. However, financial crises are difficult to predict, and each crisis tends to give rise to new rules.