My January 2015 and 2016 columns dealt with proposed changes to the international standards by which banks are required to calculate their risk-based capital. “Basel Committee Proposes Changes to Standardized Approach Capital Rules,” NYLJ, Jan. 14, 2015; “Revised Proposed Changes to Capital Requirements,” NYLJ, Jan. 13, 2016. Those changes have now been finalized and my column this month highlights some of the major revisions.

Background

Generally, there are two recommended methods by which banks can calculate their risk-based capital issued by the Basel Committee of the Bank for International Settlements, which proposes international bank capital standards. The first is the Standardized Approach, under which specific tables and formulas are used to calculate a bank's risk-based capital; the current calculations are derived from the original 1988 recommended risk-based capital requirements (commonly called Basel I). The second method, which was part of major revisions starting earlier in this century, commonly called Basel II and III, is the Internal Ratings-Based (IRB) Approach and allows a bank, with regulatory approval, to use its own internal risk management systems to calculate the risk weight of its assets and its risk-based capital.

Generally, only the largest most complex banks use the IRB Approach, ones which presumably would carry the most complex risky assets. Most banks use the Standardized Approach. There was no general requirement that the IRB Approach to calculating a bank's risk-based capital correlate with the Standardized Approach.

In late 2014, the Basel Committee expressed concern about what it perceived as excess variability in how assets were risk-weighted by those using the IRB Approach which resulted, at times, in a lower risk weight for an asset than if the asset had been risk-weighted using the Standardized Approach. The Basel Committee proposed revisions to the methods by which assets were risk-weighted. Initial and revised proposals were issued for public review, comments were analyzed, the Basel Committee assessed the impact of the revisions of the banking system and macro economy, and protracted negotiations took place among central bankers and banking regulators. Final agreement was reached in December 2017 and the final revisions were published. Basel Committee on Banking Supervision, “Basel III: Finalising post-crisis reforms,” December 2017.