The stars in the Basel sequels
Basel looms once again. Indeed, it seems there was never a time when the cultural capital of Switzerland did not hang over the world's capital markets. This time around, Basel 4 is causing concern, with stories about banks having to raise billions to meet the new standards.
It is actually Basel 3.1 this time, or if you prefer, why not Basel 4. The international bank regulatory framework has as many numbers as the Star Wars franchise, but is less fun.
A key point this time is the implementation timetable. There is a good deal of variance across the globe on when, and even if, the new standards will come into force – ranging from east to west. Talk to Japanese bankers and they are fully onboard with the new standard and the effect it is having on their business. Going westward, Europe is on the verge of adoption, but further west still the US is backing away from the proposals and looking at implementing weaker versions.
The impact to date on project finance appears to be limited. The big three Japanese banks still sit astride the PF league tables from Olympian heights. In Q3, MUFG and SMBC comfortably topped the loan league tables, with Mizuho sixth, up from 10th this time last year. Bankers at these groups point out that long-term project lending is now tough for them – for example, there are no Japanese banks on the 22-year Sizewell deal despite cover from Bipfrance, but they still do it in some instances. And in any case the project loan market across the globe has generally moved to shorter duration deals.
MUFG and SMBC lead the way in the booming US market, which accounts for half of global PF loans this year and is very bank-friendly in terms of shorter loan tenors. That said, to digress, how do all the Basel sequels cope with a US$38bn US data centre project financing? An interesting risk-weighting exercise. The Japanese banks are down into the lower Top 10 territory in EMEA and on top in Asia Pacific. That has always been the case, so yes, there has been a limited impact on PF from Basel 3.1 thus far.
The picture is the same for another stalwart of the PF market – the Australian bank sector, which has implemented the new standards. Not much has changed for them, although, that said, when taking a look at a syndication list for the large Asian deals, there is a much wider variety of Asian banks now than compared with a few years ago.
So where will Basel 4 really bite? Probably in Europe. One important reform in Basel 4 is constraining the use of the internal rating-based approach by placing limits on certain inputs used in calculating credit risks. The new output floor sets a lower limit on the capital requirements of the internal models used to calculate risk-weighted assets. The output floor is set at 72.5% of a standardised model, phased in from 50% over five years.
European banks are said to use the internal ratings-based model approach more than most and the regulators have found banks with a higher level of internal rating have lower average risk-weightings. Research from BearingPoint showed banks from Sweden, Denmark, the Netherlands, Belgium and Ireland use internal models more extensively.
That said, the mainstream French, Spanish and Italian banks were not too far behind. What about the German landesbanks? Not the force of yesteryear but still making noise. They too will be impacted by the output floor. Take a look at a syndicate list on any European deal and again, as in Asia, there is a widening choice of names – plus of course the private market.
Whatever the precise ratios, those banks using internal ratings will be sensitive to the output floor. External ratings can be used for specialised lending classes such as project finance. If they are not available, the risk-weighting during construction is 130% and during operations 100%, or 80% for a high-quality risk.
Banks are looking to reduce balance sheet carry via securitisations/first loss sales and back leverage. First loss sales are still on the agenda, as reported in PFI today. Back leverage is possible but only for higher yielding credits at plus 250bp.
Canadian banks are busy implementing the new standards but over the border it is a different story. The Basel III Endgame, a very Hollywood way of saying Basel 4, was not implemented during the Biden presidency due to fears that it could have led to big increases in capital requirements. During the Trump presidencies, the focus has been more on lower interest rates and a more benign regulatory framework. The proposals during the Biden era, which came following the regional bank collapses, would have followed the approaches taken elsewhere – restricting internal models and recalibrating risk-weighting of assets.
The Fed could now row back from that in new ideas expected in the first half of next year. Data centres could present a first test.
