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Proposed Basel IV deal would hit European banks hard

A preliminary global deal on banks' risk calculations looks set to push up capital requirements for loans to house-buyers and companies, potentially handing lenders a massive bill, though analysts cautioned that details of the so-called Basel IV rules were still sketchy and the Bundesbank said a final agreement still had to be reached.

Banks using their own internal models to calculate the riskiness of loans will have to post at least 75% of the capital against their exposures that would have been called for under standard models provided by the Basel Committee on Banking Supervision, according to the preliminary deal, S&P Global Market Intelligence understands.

The agreement, which would be phased in by 2025 and also calls for a surcharge on the leverage ratio for global systemically important banks, is intended to crack down on what members of the Basel Committee suspect is abuse of rules allowing bigger lenders to make their own risk calculations. The forthcoming standards, meant as the finishing touches to the Basel III post-crisis banking reforms, will not significantly increase overall capital requirements for banks as a whole, the committee has said, although it stresses that some lenders could be more affected than others. Bankers in Europe, where lenders have more mortgages and loans to companies on their balance sheets than in the U.S., have lobbied furiously against the proposals they call Basel IV, which they say might force them to raise hundreds of billions of dollars in additional capital.

Details of what will be a complex agreement with many parameters, including revisions to the Basel Committee's own standard model, are still unavailable. But it looks set to hit European banks hard, said Patricia Jackson, a senior adviser at EY who previously served on the Basel Committee and as head of the Bank of England's financial industry and regulation division.

"I think that floor might well put too much pressure on European banks given their high-quality mortgage books and high-quality corporate, unless the standardized approach is made much more risk sensitive," she said.

The leverage ratio surcharge for the world's biggest banks, which would be 1% for those included in the Financial Stability Board's 2% bucket, could also "be a real stretch and distort business," Jackson added. The leverage ratio is a requirement for capital as a percentage of total assets, without any risk-weighting calculations.

Not final

The preliminary agreement, reached after a meeting in Santiago, Chile, must still be approved by the Basel Committee's governing body, the Group of Governors and Heads of Supervision, in the new year.

A spokeswoman for Germany's Bundesbank said the deal was not final, adding: "Substantial progress has been made in Santiago, but important points remain to be agreed."

Earlier this year, the European Banking Federation estimated that the likely Basel changes would increase capital requirements for European banks by more than 50%, forcing them to raise an additional €850 billion in capital.

The European Commission said in November that it would not implement a deal that would require the continent's banks to boost capital significantly. Officials from Japan and Canada shared some of the European concerns, but bank representatives from the U.S., where lenders remove mortgages from their books by selling them to Fannie Mae or Freddie Mac and companies rely more on bond markets for financing, broadly supported the changes.

Banks in countries such as the Netherlands, where lenders using internal models assign risk weights near 10% to their historically very safe mortgage loans, would have to raise substantially more capital with a 75% floor. The standardized model assigns a risk weight of 35% to residential mortgage loans, yet early versions of proposed changes would have boosted this to 45% for loans with loan-to-value ratios of 80% or above, and to 55% for LTV ratios of more than 90%.

Even with a capital floor of 70%, risk-weighted assets at Sweden's Svenska Handelsbanken AB (publ) could jump by 60% for credit risk, according to research by KBW analysts led by Hari Sivakumaran, using earlier versions of Basel's proposals. They said Lloyds Banking Group Plc would see a jump of more than 20%, while international banks such as HSBC Holdings Plc and Banco Santander SA would see much less of an impact. A capital floor would have to be set at 26% for the impact on risk-weighted assets to be neutral, the analysts said.

Yet while the few known details of the preliminary agreement seem set to hit European banks hard, it will be impossible to know for sure until final details are announced, CreditSights senior analyst Simon Adamson said. The way in which the rules are incorporated into European law could also significantly reduce their impact, he added.