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Basel IV in limbo as Europe digs in, world waits on Trump

Negotiations over major revisions to the way banks calculate risk, which could force them to raise hundreds of billions of dollars in capital, are in limbo for the foreseeable future, sources have told S&P Global Market Intelligence.

The determination of European officials to avoid measures that increase banks' capital requirements has combined with uncertainty over whether U.S. President Donald Trump will loosen financial regulation, forcing a pause in discussions within the Basel Committee on Banking Supervision, two sources briefed on the matter said.

"We are in a wait-and-see mode," said one Brussels-based industry source. "Some talk [is] going around that early March could see the next GHOS meeting, but that is just talk. Nothing confirmed."

The Basel Committee's governing body, the group of central bank governors and heads of supervision, or GHOS, was due to gather Jan. 8 in Basel to decide the final version of the rules widely known as "Basel IV", but its head, European Central Bank President Mario Draghi, postponed the meeting without rescheduling it.

A second source with knowledge of the talks warned: "Many European politicians and some European bankers are wishing that Basel [IV] would be killed off."

"There are some national bankers and politicians in many countries who foolishly believe that banking and lending to the economy can be 'liberated' without the 'stifling' requirements of Basel. Their joy would be short-lived if Basel IV is ignored in Europe and taken up elsewhere. Authorities in countries that [will] have adopted it will refuse branch and subsidiary licenses."

"It would be sensible to keep trying on Basel IV," the source added, confirming that negotiations are in limbo at present. Both sources requested anonymity due to the sensitivity of the matter.

The raft of rule changes is intended to complete Basel III reforms to bank regulation, which boosted requirements for capital as a percentage of risk-weighted assets in the wake of the financial crisis, as well as to allay suspicions that some banks minimize the reserves they must hold.

Dubbed "Basel IV" because of their potential impact, the new standards would restrict the use of banks' in-house models for calculating risk weightings, reform Basel's own standard risk models, and impose minimum output floors for the amount of capital that has to be held against loans and other assets. Such changes would hit lenders in Europe particularly hard, due to their large corporate and mortgage loan books, and local industry groups have calculated they might have to raise hundreds of billions of dollars in additional capital.

Output floors could 'do a lot of damage'

The likelihood of a Basel IV deal is now only 50-50, according to a former member of the Basel Committee, Patricia Jackson, now an adviser on regulation at EY.

"The distance between the negotiating parties is quite big, particularly on the issue of the output floor," Jackson said, adding: "The output floors could potentially do a lot of damage in Europe, where banks hold high-quality mortgage and high-quality corporate loans on their balance sheets to maturity."

The European Banking Federation has said no agreement at all would be "better than an agreement that deeply penalizes the European economy." European banks argue that if they have to hold on to too much capital, it would become uneconomic to lend, leading to a credit crunch. Bankers in Japan and Canada are also concerned by Basel IV, but U.S. banks face less impact because of well-developed markets for corporate bonds and securitization, allowing them to sell on the bulk of the mortgage loans they originate.

"It is becoming a philosophical disagreement," Jackson said, suggesting that an output floor for internal models equivalent to about 60% of the capital resulting from standard model calculations should be acceptable to European officials, if given a "very long period of implementation."

The Basel Committee wants a 70%-80% output floor.

A 75% floor would cut average common equity Tier 1 capital ratio by 275 basis points in a sample of nine top European banks, according to KBW. CET1 would fall by 195 basis points under a 55% output floor, the same report found.

Meanwhile, the U.S. position vis-à-vis banking regulation in general and Basel rules in particular might change, as the new administration came to power Jan. 20 with a mandate to reduce legal burdens on all businesses. "Trump is an unknown quantity for now," said Jackson. The Brussels source also said uncertainty over the position of the Trump administration is contributing to the stalemate.

Trump promised he would cut back regulation adopted under President Barack Obama, although it remains unclear which specific rules he might be referring to.

The ECB did not respond to a request for comment on the Basel IV talks, and the Bank of England said it did not wish to comment.