Regulators set to raise capital requirements on banks
Even before this year’s banking failures, the coming of Basel IV was already set to hike bank capital requirements – and so further boost SRT trades.
At some point in the next few weeks, the US Federal Reserve will likely issue a formal notice of proposed rulemaking on how US banks must comply with the revised capital rules that the Basel Committee on Banking Supervision finalized at the end of 2017.
The most important aspect of what regulators continue to describe as Basel 3.1, but which almost everyone else calls Basel IV, is that it will reduce the larger and more sophisticated banks’ ability to game the regulatory capital regime with their own internal ratings-based risk models.
Basel IV imposes an output floor that limits the risk weighted assets (RWAs) and associated capital requirement those internal models throw out to no lower than 72.5% of what would be required under the more basic standardized approach.
The suspicion took hold after the great financial crisis (GFC) that certain banks had claimed to be carrying lower risk – and therefore to require thinner cushions of regulatory capital – than they really were on certain exposures that were core to their business models, such as residential mortgages.