What are the Basel 3 Final Reforms (B3F)?
In Hong Kong, the Hong Kong Monetary Authority (HKMA) has been collaborating closely with the financial industry to facilitate the smooth implementation of Basel 3 Final Reforms (B3F). While the HKMA closely aligns with BCBS standards, it incorporates specific adjustments to address the unique characteristics of the local market. The primary goal of B3F is to address weaknesses in the pre-2008 financial crisis regulatory framework.
Key areas of focus include:
→ Ensuring banks maintain sufficient high-quality capital
→ Addressing the pro-cyclical accumulation of leverage
→ Promoting prudent liquidity management
→ Reducing exposure concentration risks
Tackling the systemic risks associated with “Too Big to Fail” global systemically important banks (G-SIBs). A central objective of B3F is to improve the consistency and credibility of risk-weighted asset calculations across banks. This reform seeks to enhance the comparability of risk-weighted capital ratios, ensuring they accurately reflect the financial stability of institutions.
What are the revisions under Basel III Final Reforms (B3F)
1. Credit Risk – Standardized Approach
→ B3F enhances granularity and risk sensitivity in calibrating credit exposures→ It reduces over-reliance on external credit ratings, introducing a more detailed framework for unrated exposures
2. Credit Risk & Internal Ratings-Based (IRB) Approach
→ B3F restricts the use of internal models for portfolios with limited historical data→ Introduces minimum floor values for bank estimates and tighter requirements for estimation practices
3. Credit Valuation Adjustment (CVA) Framework
→ B3F eliminates the internal model approach→ It introduces a revised standardized approach and a basic approach
4. Operational Risk Framework
→ Replaces the two existing standardized approaches with a single non-model-based revised standardized approach→ Parameters are adjusted to better reflect operational risks
5. Output Floor
→ Implements a revised standardized approach-based output floor to cap capital benefits from internal models→ The floor is phased in from 2025 to 2030, reaching 72.5%
6. Leverage Ratio
→ Revises the leverage ratio framework, introducing a leverage ratio buffer for G-SIBs→ Includes technical adjustments to the original regulation
7. Market Risk Framework
→ Updates the market risk framework to reduce incentives for regulatory arbitrage between trading and banking books→ Revises the Internal Models Approach (IMA) to better capture tail and liquidity risks
→ Introduces a more risk-sensitive standardized approach as a credible fallback to the IMA
8. Disclosure requirements
→ Establishes new disclosure templates and tables for consistent, comparable reporting across banks.Who does B3F affect?
B3F applies to all authorized institutions incorporated in Hong Kong. Key regulatory divisions include:
→ Part I: Summary Certificate on Capital Adequacy Ratios
→ Part II: Capital Base
→ Part IIIa-IIIe: Risk-weighted amounts for Credit Risk (various approaches)
→ Part V: Operational Risk
→ Part VI: Sovereign Concentration Risk
Applicability notes:
- Parts I, II, and V are mandatory for all reporting institutions
- Parts IIIa to IIIc require institutions to submit forms corresponding to their credit risk approaches for non-securitization exposures
- Parts IIId, IIIe, and VI apply only to institutions with relevant exposures
Implementation timeline:
- Standards related to credit risk, operational risk, market risk, CVA risk, and output floor take effect on January 1, 2025
- Reporting-only requirements for market risk and CVA risk began on July 1, 2024
Key challenges to B3F compliance
→ Accountability to drive reforms
Authorized institutions may require making changes to their systems, models, controls and related processes. Senior management must demonstrate capability and accountability to drive these changes and build capacity for effective implementation.
→ Complexity in RWA calculations
Firms must recalibrate their RWA calculations to align with the new risk-sensitivity and output floor standards, which can be resource-intensive. Understanding localized deviations and regulatory interpretations requires specialized expertise.
→ Data and reporting requirements
Enhanced data accuracy and transparency call for significant upgrades in systems to meet the new regulatory reporting standards. Proper documentation is essential to support internal and external audits and ongoing monitoring.