Basel III Implementation Updates

Weighing You Down: The new Capital Requirements proposed under Basel III Endgame will prove onerous for Banks & Borrowers, alike. Today, I examine the Commercial Real Estate sector since this asset class is highly reliant on banks (and vulnerable) and the CRE market is contending with a huge pending maturity wall. Banks account for ~50% of the CRE debt market, representing the largest collective lender to CRE - this equates to nearly $3T in the U.S. alone. Below, I have constructed a table that very clearly states (my source from various federal documents that include: Note 20.86 on the Basel Framework (BIS) & Page 164 of September 2023 FDIC Proposed Rules notice) how a bank must measure its cash reserve requirements (CRR) for a given loan. Notice the change in risk weightings required for a given LTV. For a given loan, ~+20% higher risk weighted capital will be required that will soon be subject to this new measurement for risk. The bank lender will be required to hold additional capital for a given loan, or alternatively, simply extend less credit when writing a new loan as they apply more conservative detachment points (e.g. $50M loan vs. $100M asset value which is 50% LTV vs 80% LTV previously). If the bank does not want to increase its CRR, it must reduce the amount of credit it extends for a given asset/borrower. The delta is stark; this is a paradigm shift that will crack the door wide open for Private Credit Lenders. Banks will differentiate, take a more discerning eye when extending credit, with greater discipline going forward under Basel III Endgame. The new Basel III Endgame capital guidelines required by federal banking regulators and implemented in 2025 will break down risk-weighted assets by blending what is considered senior-secure risk v. unsecured risk (within a single unitranche loan). Regulators are confident that by imposing stricter capital requirements and more onerous stress tests when reporting liquidity, assets, operations, capital requirements, large banks (30 banks in U.S. with assets greater than $100B) will become less risky and less prone to failure. Banks are with their regulators to push back on Basel III Endgame capital charges; I am sure Banks will find a middle-ground with their regulators, but it will still result in additional and significant costs and more conservative lending practices. Private Credit firms such as Marathon Asset Management will provide a critical role in filling the void, to partner with banks and originate a plethora of investment opportunities that arise: - Mezz debt loans to fill the capital gap as banks roll loans at lower LTVs - Private Credit gaining more market share as banks reduce ABL exposure, for all ABL segments (not just CRE) - Asset Sales by banks - CRT/SRT transactions as private capital allows banks to offload risk - Private Capital & Bank Investment - Management Partnerships The current ratios vs. the proposed ratios are starkly contrasted in this table below:

With the release of Q1 2025 earnings and subsequent disclosures (namely Pillar 3 reports) from several Global Systemically Important Banks (#GSIB), the result of the implementation of the new Basel III reforms related to specific risk categories showed a large impact on Risk Weighted Assets (#RWA) composition and increase. BNP Paribas for example witnessed a 56% increase in its CVA Risk Capital in comparison to the same period in Q1 2024. One such impact pertains to Credit Valuation Adjustment (#CVA) Risk Capital. As defined by the Basel Committee, CVA stands for credit valuation adjustment specified at a #counterparty level. 𝗖𝗩𝗔 𝗿𝗲𝗳𝗹𝗲𝗰𝘁𝘀 𝘁𝗵𝗲 𝗮𝗱𝗷𝘂𝘀𝘁𝗺𝗲𝗻𝘁 𝗼𝗳 𝗱𝗲𝗳𝗮𝘂𝗹𝘁 𝗿𝗶𝘀𝗸-𝗳𝗿𝗲𝗲 𝗽𝗿𝗶𝗰𝗲𝘀 𝗼𝗳 𝗱𝗲𝗿𝗶𝘃𝗮𝘁𝗶𝘃𝗲𝘀 𝗮𝗻𝗱 𝘀𝗲𝗰𝘂𝗿𝗶𝘁𝗶𝗲𝘀 𝗳𝗶𝗻𝗮𝗻𝗰𝗶𝗻𝗴 𝘁𝗿𝗮𝗻𝘀𝗮𝗰𝘁𝗶𝗼𝗻𝘀 (#𝗦𝗙𝗧𝘀) 𝗱𝘂𝗲 𝘁𝗼 𝗮 𝗽𝗼𝘁𝗲𝗻𝘁𝗶𝗮𝗹 𝗱𝗲𝗳𝗮𝘂𝗹𝘁 𝗼𝗳 𝘁𝗵𝗲 𝗰𝗼𝘂𝗻𝘁𝗲𝗿𝗽𝗮𝗿𝘁𝘆. Two options for calculations are available: a) the basic approach (BA-CVA) and b) the standardized approach (SA-CVA). The BA-CVA is similar to the current standard approach, a conservatively calibrated approach that is relatively simple to implement. The SA-CVA is based on #sensitivities and a 𝘃𝗮𝗿𝗶𝗮𝗻𝗰𝗲-𝗰𝗼𝘃𝗮𝗿𝗶𝗮𝗻𝗰𝗲 𝗺𝗼𝗱𝗲𝗹, whose input parameters are subject to various requirements and whose application requires prior supervisory approval. These approaches will replace the current standard method and model-based advanced method. The present compilation provides detailed information on the new CVA Risk Capital framework and includes the following: 1. BCBS & OSFI Canada: Credit Valuation Adjustment (CVA) Risk 2. BASEL IV Updates -CVA Framework: Key Facts, Considerations and Actions to Take 3. IMPACT OF THE NEW CVA RISK CAPITAL CHARGE 4. Default Process Modeling and Credit Valuation 5. Modeling Credit Valuation Adjustment and Wrong Way Risk 6.  Attributing changes in CVA risk capital charge for OTC derivatives portfolio, 7. The CVA trade-off: Capital or P&L? 8. Modern Credit Value Adjustment 9. Efficient Simulation of FRTB CVA Risk Capital 10. CVA Risk Framework: Regulatory Background and Calculation Steps Presentation #riskmanagement #marketrisk #counterpartyrisk #creditvaluationadjustment #riskweightedassets #capitaladequacy #solvency #riskassessment #standardizedapproach #SA #riskcapital #capitalcharge #FRTB #defaultrisk #OTC #derivatives #settlementrisk #BCBS #financialinstruments #WWR #wrongwayrisk #valuationadjustment #XVA #internalmodeling #information #resources #knowledge #hedging #outputfloor #risksensitivity #variance #covariance

As we kick off the new year, we’ve reached a major turning point: the final set of Basel III requirements is now applicable to all EU banks. The implementation of the Basel III international standards in the EU is a major milestone, as it finalises the prudential regulatory reform of the banking sector initiated in response to the 2008 global financial crisis. This reform provides an important additional layer of resilience to the EU banking system. We hope to see similar progress soon in other jurisdictions, notably in the US, which will be crucial in ensuring financial stability and a level-playing field globally, which are both necessary conditions for the competitiveness of the EU economy.   The journey towards the EU’s Basel III implementation is not over yet and further work is needed in two key areas: first, the adoption of the regulatory and implementing technical standards that the European Banking Authority (EBA) was mandated to draft to operationalise the newly introduced requirements and, second, deciding on the way forward as regards the market risk aspects that were postponed by one year.   Work on the technical standards linked to the Basel III implementation in the EU is progressing well. The EBA has started to deliver on its mandates (full list at the link below), launching public consultations on several draft technical standards, gathering valuable feedback and comments from stakeholders. Two key implementing technical standards on reporting and disclosure by banks were published a few days ago and other technical standards that are essential for the functioning of the new framework have been prioritised and are forthcoming.   The date of application of the market risk prudential requirements under Basel III (the “Fundamental Review of the Trading Book”, FRTB) has been postponed by one year in the EU, by means of a delegated act, adopted by the Commission in July 2024 and endorsed by co-legislators in October 2024. However, the underlying concerns that prompted the Commission decision, such as issues in other major jurisdictions with the implementation of the Basel III standards, which could create an international unlevel playing field for banks in their trading activities, unfortunately are still there. The Commission will continue its monitoring of the international implementation of Basel and will engage with the co-legislators, the EBA and other stakeholders before deciding on the next step for the FRTB. This will be a priority for the Commission in 2025.   But today we should focus on the major achievement that the implementation of the Basel III standards represents for the EU. It ensures that the EU banking sector remains resilient and effectively supervised, ready to meet the new challenges we face. The stability of the EU banking system is the bedrock of the EU’s competitiveness. 📃 More info on the EBA’s roadmap on the implementation of the banking package 👇

Big news re: bank regulatory capital! On Tuesday the Federal Reserve Bank's Vice Chair for Supervision Michael Barr (pictured) unveiled changes to the "Basel III Endgame" regulatory capital requirements introduced in July 2023. What is regulatory capital? In the wake of the Global Financial Crisis, governments agreed to increase the amount of capital that banks needed to hold against potential loan losses and make the standards for measuring this capital more uniform. This "regulatory capital" – in the form of stock, cash, retained earnings, etc. – is able to absorb losses from bad loans made by a bank so that the deposits held by the bank are safe. Why does it matter? Every dollar that a bank holds in for regulatory capital is a dollar that cannot be loaned out by the bank. Practically, increasing regulatory capital will result in a bank making fewer loans. Who cares? On one side are pro-regulation anti-big bank advocates like Senator Elizabeth Warren, who argue that increased regulatory capital requirements are necessary to avoid putting the American people on the hook to bail out failed banks. On the other side are the banks, who argue that tightening regulatory capital requirements will hurt the economy by decreasing the amount of cash available for loans and will especially harm people with shakier credit who are more likely to have trouble getting a loan. What were the changes? While Barr's speech was just a preview of detailed changes to come, the big news is that, for the biggest banks (i.e., global systematically important banks), their capital requirements will increase by only 9% as opposed to 19% under the original proposal. The increase in regulatory capital will no longer apply to midsized banks with $100 billion to $250 billion in assets. What implication does this have for #FundFinance? When the initial regulatory capital proposal was circulated, I saw many banks pull back on their fund finance lending. They reasoned that, if there was less money available to lend, they would be more selective in the opportunities that they pursued, and the risk/return profile of certain fund finance products did not justify the regulatory capital cost. This accelerated the movement of #PrivateCredit lenders into the fund finance space, particularly into NAV lending. The revised proposals may increase participation and competition in the fund finance market, particularly since regional banks have often been leaders in this industry. What do I think? Despite the posturing by both sides, the best approach is a balance between the two competing concerns. It is worthwhile to increase the required capital cushion of banks to lower the likelihood of bank failures. On the other hand, increasing the capital cushion does come at a cost to the economy and consumers, and that needs to be seriously weighed against any benefit. Practically, I suspect there will not be much movement here until after the US presidential election in November.

The PRA published the second near-final policy statement on Basel 3.1 standards, focusing on credit risk, the output floor, and reporting and disclosure requirements.    This statement provides clarity on future capital requirements and promotes a more balanced, risk-sensitive approach to regulatory capital, particularly for SMEs, infrastructure, and trade finance.   Key highlights relative to today include: - No increase in capital requirements for SME and infrastructure exposures - Simplified approaches for residential property valuations - Maintaining the existing conversion factor (CCF) for trade finance - Residential property valuations moving towards a simpler risk-sensitive approach - Adjustments to output floor calculation The implementation date has been moved to January 1, 2026, with a transitional period until the end of 2029. Additionally, the PRA released proposals under the Strong and Simple capital regime for smaller firms, aiming to simplify capital requirements for Small Domestic Deposit Takers (SDDTs), with implementation expected by January 1, 2027.