Navigating Basel III End Game – The Key to Future Compliance

by Ajay Katara

The Basel guidelines, developed by the Basel Committee on Banking Supervision (BCBS), have evolved through three major iterations. Basel I, introduced in 1988, focused on credit risk, setting minimum capital requirements for banks. Basel II, launched in 2004, expanded the framework by including operational risk and enhancing risk management practices. Basel III, initiated in response to the 2008 financial crisis, introduced stricter capital and liquidity requirements to improve banking sector resilience. The Basel III Endgame (B3E) is the latest version of the reforms which are planned to be implemented by 2025 and will bring about significant changes in the US Risk based capital framework.

The U.S. Notice of Proposed Rulemaking (NPR) for Basel Endgame (B3E) will substantially change the capital requirements for U.S. banks, with a compliance date of July 1, 2025. Banks will have about two years to adapt to the new expanded risk-based approach (ERBA), including data and technology adjustments. Data governance will be crucial for meeting these timelines and ensuring accurate reporting. The proposal applies to banking organizations in Categories I–IV, including US intermediate holding companies (IHCs) of foreign banking organizations (FBOs). The proposal also includes a three-year transition period for ERBA risk-weighted assets (RWA) and for Category III and Category IV banks to comply with the elimination of the accumulated other comprehensive income (AOCI) opt-out election.

Some of the Key Amendments are listed below:

1. Strengthened & increased Capital Requirements – One of the central elements of the Basel III Endgame is the revision of capital requirements to ensure that banks maintain sufficient buffers against potential losses. The reforms introduce a more standardised approach to calculating risk-weighted assets (RWA), which serve as the basis for determining a bank’s capital needs. This change is intended to reduce the variability in RWA calculations across different banks, which has been a concern under the previous Basel III framework.
   In the United States, banks will need to adjust their capital strategies to meet these more stringent requirements. For large banks, this could mean increasing their capital reserves, particularly for assets that will now carry higher risk weights under the new standardised approach. This may prompt banks to reassess their portfolios, potentially reducing exposure to higher-risk assets or seeking to offload them to non-bank financial institutions. The Proposed Rule would significantly increase capital requirements for Category I – IV banking organisations, with the largest increase occurring for the U.S. GSIBs.
2. RWA Calculation Changes – The Proposed Rule would remove the Advanced Approaches for determining capital requirements for credit and operational risk, replacing them with a standardised ERB Approach based on the revised Basel Framework. It also proposes replacing the current U.S. market risk capital rule with a new Subpart F that covers both market and CVA risk. For market risk, banks could choose between the Standardised Measure or, with approval, a Models-based Measure. Category I-IV banking organisations would need to calculate two primary measures of total RWAs under Standardised Approach and Expanded Risk Based Approach (ERB)
3. Regulatory Disclosures – The Proposed Rule would revise certain existing qualitative disclosure requirements and introduce new ones to align with changes to the capital rules. It would eliminate disclosure requirements related to internal ratings-based systems and internal models, reflecting the proposed removal of the Advanced Approaches. Most existing quantitative disclosures would be removed from the required disclosure tables and included in regulatory reporting forms instead. The Agencies plan to revise regulatory reporting forms such as FRY-9C, FFIEC 101, FFIEC 102, FRY-14A, -14Q, and FRY-15 to reflect these changes. Enhanced public disclosure and reporting requirements, previously applicable to Category I and II banking organisations, would now extend to all Category I-IV banking organisations. The top-tier entity in the banking organisation would be subject to both the qualitative and quantitative enhanced disclosure and reporting requirements.
4. Enhanced Risk Management – The Basel III Endgame places a strong emphasis on improving risk management practices across the banking sector. In particular, the reforms introduce a new operational risk framework that is more standardised and less reliant on banks’ internal models. This change is intended to enhance the comparability of risk metrics across banks and reduce the potential for model manipulation.
   In the U.S., banks will need to invest in upgrading their risk management systems and processes to comply with the new requirements. This may involve adopting more advanced data analytics and risk assessment tools, as well as enhancing governance and oversight mechanisms. The focus on operational risk also means that banks will need to pay closer attention to risks related to cybersecurity, fraud, and other non-financial threats, which have become increasingly significant in the digital age.

To navigate the challenges posed by the Basel III Endgame, U.S. banks will need to adopt a proactive and strategic approach. This may involve reassessing their capital allocation strategies, diversifying revenue streams, and investing in technology to enhance efficiency and risk management. Banks that successfully adapt to the new regulatory environment will be better positioned to compete in a more stringent and complex landscape.

The author, Ajay Katara, serves as a consulting partner and leads the Reg Tech portfolio within the banking risk management domain at Tata Consultancy Services. With over 19 years of expertise in business consulting transformation and solution design, he navigates regulatory compliances in the areas of Regulatory Capital Management, Credit Risk, Climate Risk, Stress testing and Anti Money Laundering. Operating across diverse geographies, Ajay has collaborated with numerous financial institutions and enterprises. His substantial contributions to conceptualising strategic offerings in risk management and his impactful role in driving successful consulting engagements underscore his influence. He has also been awarded the Risk Management Professional of the Year award by CIRM Magazine UK in 2023.