In the latest issue of Nordea On Your Mind, "Corporate lending under Basel IV", we explore what has led to the implementation of Basel IV and what the likely implications will be for banks and for corporate borrowers.
Banks are supervised by national regulators, but since 1973, bank regulations have been co-ordinated globally by the Basel Committee of the Bank for International Settlements (BIS), jointly owned by 63 central banks from countries that together account for 95% of global GDP. Its first framework, Basel I, was introduced in 1988 and followed by Basel II in 2004 and Basel III from 2013. The finalisation of Basel III has become so comprehensive that it is increasingly seen as an entirely new framework, and commonly referred to as Basel IV, to be introduced from 2023.
Aiming for strengthening the banking system and harmonising risk models
Basel IV aims to make the global banking system more robust. Banks will generally need to increase their capital reserves to further improve their ability to absorb credit losses. Confidence in how banks assess credit risks will be addressed by sharply limiting the use of internal advanced risk models, leading to more widespread use of standard risk models and fewer regional and country variations in how risks are assessed and measured.
Banks losing benefits from internal risk models
The price of making banks use the same standard risk models to a much greater extent is that they are less sophisticated, have arguably not performed better historically, and do not give some borrowers benefits which they deserve from a credit risk point of view. Banks that have relied heavily on advanced internal rating models may find the economics of their lending significantly worse under Basel IV. According to the European Banking Authority, the European banking system will need to raise almost 20% additional Tier 1 capital after Basel IV is implemented. Banks in Europe, and particularly in the Nordic region, will be among the most affected globally.
Corporates should consider the merits of diversified funding and a credit rating
We believe banks will need to generate a return on the additional capital they need to hold. The most affected lenders will include heavy users of advanced internal rating models. They will need to adjust pricing or reduce exposure to the most affected borrowers, such as large corporates without a credit rating, unless they are prepared to accept lower returns. We believe corporate borrowers should evaluate their access to capital markets funding, and how to optimise it, (such as by obtaining a rating) to have maximum flexibility when Basel IV is implemented. We expect Basel IV to further stimulate the already substantial migration from bank to bond funding by Nordic large corporates seen over the past decade.
Views from the experts
To understand what has led to the introduction of Basel IV and what its likely implications will be for banks and for corporate borrowers, we have interviewed Anders Kvist, Senior Adviser to the Inspector-General of the Swedish FSA Finansinspektionen, as well as Timothy Farrar and Karsten Skov from LC&I Public Affairs and Balance Sheet Management – Pricing, respectively, at Nordea.