Basel IV: Capital Floor

In December 2014, the Basel Committee published its proposals for the redesign of capital floors to complement the revised standardised approaches for credit risk, market risk and operational risk. The aim is to improve the reliability and comparability of capital ratios, to restrict incentives for the deliberate use of design leeway in the application of internal models and to reduce model risk overall.

Against this background, the proposals of the Basel Committee provide for the limitation of the risk-weighted assets (RWA) determined by the banks on the basis of internal models to a minimum percentage of the capital requirement calculated according to standardised approaches. This means a de facto limitation of RWA savings through the use of internal models. The amount of the floor as well as transitional regulations for its introduction are currently being discussed controversially.

Several alternatives for the application of the floor are under discussion. An aggregate RWA-based floor comprises the sum of the RWAs of all risk categories (i.e. credit risk, market price risk, operational risk), i.e. in this case offsets between the individual risk types are possible. In the case of a risk-category based floor, the RWAs would be determined and limited at the level of the risk types. Accordingly, no offsetting between the individual risk types would be permitted. The third and most conservative variant is a floor at the exposure class level, in which no offsetting between the individual risk types as well as between the individual exposure classes is permitted.

In the meantime, there are signs of an agreement on the first variant, even though the concrete amount of the floor is still open and thus one of the last critical points of negotiation. Although the Basel Committee has expressed the intention that the planned changes will not result in higher capital adequacy requirements overall, banks that use internal models may face additional portfolio-specific burdens. The further developments and final regulations on capital floors should therefore be closely monitored in order to identify any need for action.