Wholesale Credit Regulations: An Uneven Playing Field for All

The Basel 2017 reforms have highlighted transatlantic differences in the implementation of wholesale banking regulation. There exists a significant gap between banks in the US and the rest of the world; this gap is due to genuine regional, business mix and obligor differences, as well as varying interpretations of the regulations in different jurisdictions, and differences in calibration.

Whilst the intention behind current US regulation is to foster broad and deep credit markets and prevent moral hazard and undue risk taking, some unintended outcomes have arisen as a result. Risk.net recently reported that “Five of the largest US banks are below the so-called Collins floor, meaning their modelled risk-weighted assets (RWAs) are lower in value than those calculated by regulator-set standardized approaches. A Risk Quantum analysis across the eight US global systemically important banks (G-Sibs), shows that Morgan Stanley, JP Morgan, Citigroup, State Street and Wells Fargo had higher standardized RWAs than modelled RWAs as of the first quarter 2018.”

Full implementation of Basel 2017 will partly redress the RWA penalty; but the inability to use NRSRO Credit Agency ratings, or internal modelling will be an ongoing disadvantage for US banks. In addition, current IFRS9 rules place additional charges on non-US banks but the introduction of CECL will place a heavier relative penalty on US banks.

One crucial implication of Basel 2017 is that US banks need to become quasi-rating agencies while European banks will be penalized for lending to higher quality but unrated borrowers. If local regulators recognise the value of pooled credit assessments from global banks, it is possible that they can encourage competition and reduce funding costs for a large number of high quality small and medium sized businesses on both sides of the Atlantic.

A new Credit Benchmark paper reviews the impact of this transatlantic gap upon balance sheet management, risk profiles, capital requirements and the allocation of credit. Understanding the impact of these regulations is not only important to understand the response of the banks, but for their ramifications upon their clients, counterparts and the broader economy. The paper uses a number of proprietary sources, including bank sourced credit estimates, as well as public data.

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    Credit Benchmark brings together internal credit risk views from over 40 leading global financial institutions. The contributions are anonymized, aggregated, and published in the form of consensus ratings and aggregate analytics to provide an independent, real-world perspective of credit risk. Risk and investment professionals at banks, insurance companies, asset managers and other financial firms use the data for insights into the unrated, monitoring and alerting within their portfolios, benchmarking, assessing and analyzing trends, and fulfilling regulatory requirements and capital.