Global banks will be disappointed that the Basel Committee on Banking Supervision appears to be ruling out making any major revisions to the methodology that decides which institutions are classified as global systemically important banks. By Justin Pugsley

By Basel Committee standards the consultation on the topic of global systemically important banks (G-SIBs) is very short: just one page, closing on September 3. The consultation on the G-SIB methodology normally takes place every three years. This one was delayed due to the Covid-19 pandemic and generally asked similar questions to previous feedback exercises, such as about exploring alternative methodologies and focusing on bank branches. 

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The methodology, which uses 12 financial indicators, is employed by the committee to assess factors such as a bank’s size, complexity, interconnectedness and cross-border exposures that help decide how systemic a bank is. 

“I think the creation of a G-SIB category was partly supposed to be a mechanism to make the big banks become simpler and less large,” says Michael McKee, a partner at law firm DLA Piper. He notes that this has worked to a degree, with some banks having dropped down the list or have left it completely. In last year’s rankings, published annually by the Financial Stability Board, the top two buckets out of the five were empty. By contrast, in 2012, the top category was empty, but the next one down contained four banks. 

The bucket banks fall into is important because those in the top category are required to hold 3.5% in additional capital buffers, which falls gradually down to 1% for the lowest bucket. 

However, in this consultation there is a small proposed tweak that is likely to disappoint the G-SIBs. The Basel Committee wants to swap the three-year in-depth review process for a lighter, possibly annual, monitoring exercise. 

Also, the committee, citing its oversight body the Group of Governors and Heads of Supervision (GHOS), reiterated that “any further potential adjustments to Basel III will be limited in nature and consistent with the committee’s evidence-based evaluation work”.

That suggests that the committee is happy with the G-SIB framework as it stands. Some years back, the committee took a similar decision over its regulatory consistency assessment programme. 

“Any G-SIBs hoping for a wholesale change to the methodology I suspect will be a bit disappointed, because this doesn’t seem to be the consultation by which those changes could be introduced in the future,” says David Shone, an associate at law firm Slaughter and May.

However, such is the sensitivity of the topic that most sources GRR spoke to only agreed to comment on condition of anonymity. Nonetheless, it is anticipated that the Basel Committee will probably not receive much comment from the consultation. 

Methodology dissatisfaction

“I think the Basel Committee is signalling that actually, 10 years or so on, they have a decent methodology and that the broad framework is here to stay and these big reviews are no longer needed,” says one industry source. He explains that as far as the industry is concerned there are nonetheless some aspects of the methodology that it is not happy with. “It wouldn’t surprise me if they were a bit dejected by the fact that the Basel Committee doesn’t seem to want to undertake big changes to the framework,” he adds.

A source familiar with the Basel Committee agreed that there will be little change to the framework. “It’s purely an administrative thing,” he says, explaining that the consultation is part of a committee obligation to request feedback when making a technical amendment. “In terms of substance not much has really changed.” 

As GRR understands it, the three-year in-depth reports, looking into issues such as measurement methodologies, required considerable work, but what materialised from all this effort was little real change to the framework. In the beginning these reviews were seen as necessary, but that is no longer the case.

The source confirmed that the adoption of any new methodologies or indicators would likely require a high bar, which will disappoint some big banks. 

The first industry source explains that the G-SIBs do not like that the committee, as part of its evaluation process, takes the 75 most complex and interconnected banks and compares them against each other, rather than using fixed benchmarks. 

“So one of the consequences of that is if you play a thought experiment, and undertake an exercise whereby each bank becomes less systemic, or less systemically important by the same amount, then there is no change to the scores,” the source says. The G-SIBs believe that this undermines banks’ incentive to become less systemically important.  

“What was really important to the governors and the heads of supervision [the GHOS] was consistency, predictability and replicability [of the scoring process], so banks should be able to predict what their scores will be and what bucket they’ll find themselves in,” says a second person familiar with the Basel Committee. He explains that when the framework was being drafted, most G-SIBs lobbied over how the scores are calculated. 

He acknowledges that the rankings are relative, but that the framework is designed to get G-SIBs to reduce their global footprint and currently does not need revising. He points out that some banks are very proud to be a G-SIB, as it confers a status of being among the biggest banks in the world. Also, “there are some clear benefits to being too-big-to-fail”, he says, such as lower funding costs. Many investors believe that the authorities would still bail out a failing G-SIB if necessary and probably preserve senior creditors, as happened during the 2007-9 global financial crisis. 

Eurozone complaint

According to the industry source there is also some dissatisfaction over the indicators used to rank cross-border interconnectedness and systemic relevance, particularly within the eurozone. Indeed, the Basel Committee acknowledges the issue of regional developments, particularly in the context of the European Banking Union (EBU), where reviews will be conducted independently as structural changes occur. 

The EU authorities argue that cross-border eurozone bank exposures should be treated as domestic exposures for capital purposes. However, the Basel Committee has stood fast on its position. “I think [the committee] is basically recognising a more significant role of the European Central Bank [ECB] in terms of supervising EU banks,” says Mr McKee.  

The second source familiar with the committee adds: “Sure, on paper there is a common set of rules and a common currency. But do people really think the German market is the same as the Spanish market? Or that your Spanish bank’s relationship with the French supervisor is the same as it is with the home country supervisor?” 

He points to the way some banks have been resolved in the eurozone where national interests have trumped EU ones and that the EBU is not complete. 

“So I think the committee was right to take a wait-and-see attitude. I don’t think anyone could seriously argue that there’s a single unified, complete common market in Europe,” he adds. 

He explains that the Basel Committee might start to shift its stance if it saw, for instance, a common eurozone deposit insurance scheme and the completion of the capital markets union. While he praises the ECB’s Single Supervisory Mechanism (SSM) as “a fantastic development”, he nonetheless expressed concern that national competent authorities still wield too much influence over eurozone supervision and bank resolution processes. He believes legislative changes are needed to strengthen the roles of the SSM and the Single Resolution Board.  

The second source familiar with the Basel Committee says having a unified eurozone legal framework could also make difference in the way interconnectedness is looked at within the currency zone. 

However, a further industry source warned that there is a possibility that eventually EU authorities could diverge from the Basel Committee’s treatment of cross-border eurozone exposures and unilaterally declare them as domestic to lower capital requirements for its banks. That is particularly the case if further integration is made on EBU, but is not acknowledged by the Basel Committee. 

Window dressing

Indeed, there are even some doubts over the G-SIB classification of EU banks with the Bank for International Settlements publishing a paper on August 12 called ‘Is window dressing by banks systemically important?’ It argues that several EU banks compress their scores ahead of their regulatory reporting to lower their G-SIB capital surcharges, with some avoiding designation altogether. This is done in relation to their intra-financial assets and liabilities and their over-the-counter derivatives business. (This will be covered in a future issue of GRR.

GRR understands that some US financial institutions likely engage in year-end window dressing as well. However, the US approach towards large banks is somewhat stricter than the EU’s. 

The US has its own methodology for classifying G-SIBs, published on the website of the Office of Financial Research, which differs a little from the Basel Committee’s, and includes short-term funding metrics. Banks more reliant on short-term funding are seen as potentially more systemically risky than those that are not. On that score Deutsche Bank USA is a clear leader on the US list, followed at some distance by Barclays US. GRR understands that the G-SIB capital surcharge of foreign banks is held on the balance sheet of the parent bank. If the US authorities began to see them as too risky, they could insist on the US subsidiaries of these banks holding more capital, which would fragment their capital bases and drive up their costs. 

Also, the US takes a more punitive approach to G-SIB capital requirements. For example, JPMorgan Chase attracts a 3.5% capital surcharge (reflecting higher contagion risks and leverage) while Citigroup and Morgan Stanley each have to hold an extra 3%. Under Basel, the first two banks would have to hold an extra 2% in capital and the third an extra 1%.  

Nonetheless, the committee may not be completely opposed to revising its G-SIB methodology. G-SIBs might gain some solace from the fact that in January 2020 the FSB suspended its identification of global systemically important insurers (G-SIIs) altogether in light of changes to the International Association of Insurance Supervisors’ (IAIS) approach to the assessment and mitigation of systemic risk in the insurance sector. The IAIS, which is a parallel body to the BCBS, has moved away from a strict quantitative approach and adopted what it has described as a holistic framework, says Mr Shone. He says the new framework, which is still being implemented, seeks to try and evaluate and control the interconnectedness and the systemic importance of insurance groups, according to a broader and more dynamic set of criteria.

If the IAIS settles with its new G-SII methodology, which admittedly is part of some broader revisions to its regulatory framework, there is a chance that the BCBS may one day be prepared to revisit its own G-SIB ranking process. However, that would have to be accompanied by considerable empirical data, strong arguments and another consultation. 

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