JT: What do you think the biggest changes for banks from the implementation of Basel IV will be? And how will lending to corporates be affected? Impact on availability or pricing?
JBJ & AL: The finalisation of Basel III, which you call Basel IV, will fundamentally change how capital costs are allocated. While the average impact has been significantly reduced in the Commission's recent proposal, there are still large differences within different lending portfolios.
For banks bound by the output floor, corporate exposures will see a significant rise in capital requirements – for example, for some banks they could double. In contrast, we expect a smaller impact on retail mortgage lending, as it has received more favourable capital requirements in the Commission's proposal.
Furthermore, in several countries, we expect only part of the IRB-using banks' lending to be bound by the output floor. This means that some banks will not really see a strong increase in capital requirements, while other banks – operating in the same market – will see a massive increase. This will likely impact the competitive dynamics for different customer segments, with some banks becoming more competitive in terms of pricing, e.g. within corporate exposures. As a result, banks experiencing a large increase in capital costs might be reluctant to pass on the higher capital costs to the specific customer segment – but that would still beg the question as to how they should pay the bill.
Of course, there is quite a lot going on at the moment: Ukraine, inflation, the weaning off from QE, to name a few major macroeconomic influences. It is difficult to fully disentangle all the different individual effects.
JT: Would you expect Basel IV to affect the funding strategy or mix for Nordic large corporates? Long versus short funding? Loans versus bonds? Parent company guarantees? The case for a credit rating? Other factors?
JBJ & AL: Yes. Bank borrowing will become relatively more expensive, which should trigger responses from borrowers. Bonds should become more attractive relative to loans, given the particularly high increase in capital requirements for corporates. Also, the case for a credit rating is definitely worth a fresh look, as rated corporates will receive lower capital charges. We do not really expect to see much in the downstream guarantee space: if those sorts of strategies were effective at bringing down the cost of borrowing in the first place, they should be implemented regardless of the Basel regulations.
However, we have noted that several market participants have highlighted that the proposed legislation will create barriers to securitisation of bank lending that is not warranted by underlying risks. We think this is worth looking into further, notably also in the context of the EU's wider plan to support the Capital Market Union.
JT: Do you think the current proposal for Basel IV will be the final version, or could there be more changes ahead?
JBJ & AL: I think there will likely be some changes in the trilogue process. The big question is whether the transitional arrangements proposed by the Commission will be included in the final agreement. The Commission has even left the door open to make some of these arrangements permanent. This will be very decisive for the impact on the banking sector – in particular for banks with large retail mortgage portfolios.
JT: Do you see any important areas where further research could be needed on what effects the regulations will have?
JBJ & AL: Up until now, the main focus has been on the average impact. This has beensomewhat watered down compared to the original proposal – although still significant for some banks. We think the focus will now turn to the impact on the relative capital costs for different customer segments, and how this could impact pricing for the individual banks as well as competitive dynamics in the markets they operate in.
Also, we do not really see the average impact as being the relevant metric for the evaluation of reform. Again, going back to basics, it is important that there is a strong link between actual risks and capital requirements bank-by-bank. This has, for example, also been stressed in some of the publications provided by the ECB. So, we are interested in seeing how this pans out.