The latest set of Basel 111 rules curbs banks' ability to arrive at a lower assessment of their level of risk than that calculated by regulators. The new rule says the banks' estimate, using their own internal risk models, of the total sum of assets against which capital must be held must not be less than 72.5% of regulators' estimates.
Despite a CET1 hit of as much as 10% at top Swedish Lenders following full implementation of Basel output floors, Nordic and Benelux banks will still remain relatively well-capitalised by European standards. Their Capital Adequacy edge will narrow though. Based on an output floor of 72.5% to be achieved by 2027 after a five-year phase-in period, CET1 ratios would fall a tad more than 6% on average for Nordic banks and 3% for Benelux banks. Having said that, all remain above 12.5%.
Nordic and Benelux banks are strong users of internal models for credit risk weights, driving average risk weights as low as 5% on their mortgage books. They are thus more affected by output floors. At an output floor of 72.5%, these will risk to 25% from 5%. Investment banks also use internal models for 85% or more of their lending. CET1 ratios have thus been inflated.
The timeline of a 9-year phase-in of the floors and the 72.5% final target caused few waves in the market and most banks will have an uptick in their CET1 ratios – by between 10-30bps. There was no change to sovereign treatment, and national supervisory bodies can cap RWA inflation during the transition to the new Basel 111 landscape.